Operators of Nonresidential Buildings

SIC 6512

Companies in this industry

Industry report:

The commercial real estate operation and leasing industry consists of establishments primarily engaged in the ownership and operation of nonresidential real estate. These companies own and operate properties such as retail establishments, shopping centers, marinas, theaters, and commercial and industrial buildings. The industry does not include owners of hotels, campgrounds, or other establishments that are classified as service operations.

Industry Snapshot

In 2010, operators of nonresidential buildings, including lessors of retail stores, shopping malls, and other commercial spaces, were struggling to recover from the economic recession that began in 2007. After facing devastating drops in demand and revenue throughout the late 2000s, some industry participants expressed optimism for a recovery by October 2010. For example, industry leader CB Richard Ellis reported a 24 percent increase in revenue in the third quarter of 2010, a figure that represented the strongest year-over-year quarterly revenue growth since the fourth quarter of 2007. Sources such as National Real Estate Investor called such reports "signs of life that [a] turnaround could soon be in the offing for the commercial real estate industry."

The real estate industry had experienced several significant swings during the late twentieth century. Hammered by a depression in the real estate industry that began in the late 1980s and continued into the early 1990s, commercial property owners and operators were beset with high vacancy rates, a severe shortage of capital, and dismal earnings. Many companies were not able to meet their mortgage obligations and were forced into bankruptcy. Companies that survived the shakeout learned to operate more efficiently and to compete by providing better customer service. (See SIC 6531: Real Estate Agents and Managers.)
After a continued slump in 1993, the industry bottomed out and vacancy rates in many sectors began to stabilize. The dramatically improved economic climate through 1996 was reflected in an equally dramatic recovery of the office and industrial segments, especially in suburban areas. However, the retail segment was an exception. New construction continued unfettered, so the retail market was oversaturated by 1996. Slow retail sales and numerous retail bankruptcies threatened to worsen the situation.

The unprecedented longevity of the late-1990s economic boom spilled over into the nonresidential real estate market. The unexpected continuing strength of the U.S. economy managed to keep tenant demand relatively strong during this time, particularly in the office and shopping center segments of the market. However, by the early 2000s conditions had changed. Weak economic conditions led to massive layoffs and reduced levels of corporate and consumer spending. Although the entire commercial real estate industry was affected, these conditions impacted some segments more than others. Fortunately, overall investment levels remained strong.

The mid-2000s saw significantly improved conditions as the real estate market was bolstered by historically low interest rates and a revived economy. Office and retail showed strong performances through 2006, before the economic recession that took hold in 2007 brought the entire real estate industry to a sliding halt.

Organization and Structure

The entire real estate industry is highly fragmented and has traditionally been characterized by low barriers to entry. Therefore, companies that own, lease, and operate commercial properties range from small mom-and-pop firms to large national corporations. In addition, many of the largest owners and operators of real estate emphasize other business operations and thus are not primarily engaged in the industry. For instance, some of the largest commercial property owners are insurance companies that invest some of their reserves in real estate, which they may or may not actively manage. Other owners and operators include large corporations such as IBM, which operate properties that serve their core businesses.

Companies that are primarily operators and lessors of commercial properties often specialize either by region or by property function. Those that specialize by property function benefit from an acute understanding of the market segment that they serve. Through experience, they learn how to streamline their operations and reduce costs while generating maximum revenues from a given number of square feet, or dollars invested, in a project. For example, some companies specialize in the operation and leasing of shopping malls, whereas other companies focus on self-storage facilities or office buildings.

Because the real estate industry has traditionally been highly localized, many industry participants specialize in just one geographic region or locale. For a company to own and operate a property that effectively competes for tenants, it must have an intimate understanding of the local market characteristics. These attributes include demographics, location, surrounding facilities, vacancy rates, zoning restrictions, local taxation, and future economic expectations. For this reason, very small firms that concentrate in their own community benefit from a shrewd understanding of their local market. They are also more likely to take advantage of business relationships that give them an edge in their community. Property owners that do not specialize regionally will often contract with third-party management firms that are familiar with the community in which their property is located.

Institutional Investors.
Aside from the large and small property owners, operators, and lessors who have traditionally dominated the commercial market, another type of owner/operator includes subsidiaries of large institutional investors. These companies specialize in real estate ownership and operation for their parent investment company. They typically invest in many properties in various regions, often worth millions of dollars. Asset managers employed by these companies oversee the properties and are ultimately responsible for their financial performance. In many cases the asset managers contract with, and directly supervise, local property management firms that perform on-site maintenance and lease tenant space.

Also falling into this category are lending institutions. Many of these institutions became property owners/operators by default in the 1990s as the developers to whom they loaned money failed to meet their debt obligations.

Professional and Trade Organizations.
There are several professional and trade organizations involved with this industry. The Building Owners and Managers Association International was founded in 1908 and is headquartered in Washington, D.C. Its activities include lobbying on legislative and regulatory issues, conducting training programs for property administrators, and establishing industry standards, such as the Standard Method of Floor Measurement. The International Facility Management Association, located in Houston, Texas, focuses on the management of the work environment. It conducts research, provides educational services such as facility manager certification programs, and sponsors international conferences and networking. The Chicago-based Institute of Real Estate Management, which includes both residential and nonresidential real estate, also provides educational services such as property manager certification and has established international partnerships with developing nations.

Background and Development

Commercial real estate ownership in the United States is made possible by real property laws that govern land and property rights and conveyances. These laws were originally based on English property laws that developed between the tenth and twentieth centuries and were mimicked in America as early as the seventeenth century. U.S. real property laws differ from English law, however, in that they vary significantly from state to state and even from city to city.

An important feature of real property laws in the twentieth century was the emergence of social control, which limited the freedom of property owners to use and develop land in a manner that did not serve the public good. Social control manifested itself in eminent domain, zoning laws, and police regulations. The concept of eminent domain implies that an owner's land may be taken away by government decree, against the owner's wishes, for a use that serves the public. Similarly, zoning laws restrict the functions for which owners can use their property. The 1926 case Village of Euclid v Ambler Realty Co. established the first zoning laws. The third form of social control is police regulation, by which a property owner can be directed by the state to take a specified action regarding his or her property. This concept gained momentum in the case of Miller v Shoene in 1928.

Industry Growth.
The commercial real estate operation and leasing industry became a force in the U.S. economy beginning in the 1950s. The rapid expansion of the U.S. economy, population, and workforce generated an unprecedented demand for office buildings, retail centers, commercial recreational facilities, and other types of real estate developments. Throughout the 1960s and early 1970s the amount of nonresidential property owned and operated for commercial profit continued to grow at a brisk rate, often averaging more than 1 billion square feet in new space per year.

Just as important to the industry as the demand for new properties, however, was the availability of capital for new ventures. In fact one distinguishing characteristic of the U.S. real estate industry is that its growth was traditionally driven by the amount of capital available to fund new projects, rather than by market demand. This phenomenon was largely a result of favorable tax laws that artificially boosted returns on commercial real estate investments.

The 1980s Boom.
The commercial real estate industry realized the greatest expansion in its history in the mid- and late 1980s. Owners and operators of real estate, as a group, rapidly expanded their holdings and attained enormous profits during this period. The total square feet of new commercial space developed, owned, and managed increased from an average of about 700 million per year from 1981 to 1983 to more than 1 billion between 1984 and 1989.

This boom occurred despite only a moderate surge in market demand for new real estate developments. Several factors accounted for the massive growth. Financial reasons included the deregulation of U.S. savings and loan associations, which ultimately ended in disaster when many of these associations folded after poor investment practices; an absence of bank investment alternatives, tax shelters, pension fund growth, and investment in real estate; and an influx of foreign investment dollars. Nonfinancial factors that encouraged overbuilding in the 1980s included the growth of office-based employment, increasing employment of women outside the home, the growth in office space required per worker, the oil price bust in the mid-1980s, and explosive population growth in several states.

The 1990s Bust.
By 1989, investment capital dried up, tax laws had changed, and the U.S. economy had stagnated. Property owners and operators started to suffer from the consequences of overbuilt markets. By 1990 the amount of new real estate developed fell from a six-year average between 1984 to 1989 of 1 billion square feet per year to less than 600 million square feet in 1990. High vacancy rates and diminished profits plagued owners and operators who were struggling to meet mortgage payments on their distressed properties. In addition, owners were often unable to sell their properties, even for a moderate loss, because property values had collapsed. As a result of these problems, many owner/operators were forced out of business as lenders took over their bankrupt properties.

Four major implications for the commercial property ownership and operation industry resulted from the 1980s boom and subsequent bust. The first was an increase in the ownership of properties by large institutions and a decrease in ownership by local companies that had a personal interest in management of their property. The second was the emergence of owners who sought short-term investments rather than long-term profitability. A third outcome was overbuilding, especially in office space, and the ensuing fall in effective rent rates. Finally, the collapse of lending institutions strained by nonperforming real estate loans left the industry with reduced access to capital for development and renovation, projects that the market demanded in the early 1990s.

In 1993, commercial real estate remained one of the weakest sectors in the U.S. economy. In 1992, vacancies had reached record highs, averaging more than 19 percent in the nation's business districts. As a result, owners continued to charge less rent. For instance, rent per square foot for Class A office space fell from an average $21.81 in 1991 to $21.44 in 1992. In addition, many owners offered large incentives to lure and keep tenants, such as several months of free rent, free parking spaces, and free space renovations. Most large institutional investors continued to receive poor investment returns from their real estate portfolios.

Owners sustained their search for capital to renovate or develop properties. Under a provision of the Federal Deposit Insurance Corporation Improvement Act, which became effective December 19, 1992, many lending institutions were pressured to avoid any loans that could be construed by regulators as risky. Other regulations, such as the risk-based capital standards, were tightened early in 1993, further constricting the flow of capital available to owner/operators.

Property owners also started to recognize the financial implications of the Americans with Disabilities Act, which became effective in 1992. This act mandated that owners of most new buildings provide reasonable access to their properties for disabled people. The act included thousands of regulations stipulating such details as elevator button heights, bathroom sink dimensions, door widths, and the type of locks that could be used on door handles.

In response to these and other market forces that exerted downward pressure on profits in 1993, owner/operators sought ways to reduce operational costs, increase their marketing effectiveness, and improve customer service. They used more advanced financial reporting methods, hired more highly educated and experienced property managers, and developed customer service programs.

By 1997, the overall market for nonresidential real estate had changed drastically. At that point the market could be viewed in three segments: office, industrial, and retail. Of the three, the office and industrial segments made great strides toward recovery and only the retail segment continued the slump of the early 1990s.

As the U.S. recession began to end in 1992, the economy responded by producing 8.7 million new jobs from 1993 through 1995, many of them in high technology and corporate services firms. As a result, by the beginning of 1997 office space occupancy stood at the highest level in a decade. Financially solid investors (unlike many in the 1980s) began to pour capital into new construction, particularly in suburban areas where costs of operation were lower, traffic and parking were less troublesome, and safety and quality of life were more appealing for many employees. Grubb & Ellis' 1996 Real Estate Forecast estimated that suburban office space accounted for 75 percent of the office demand since 1990. Suburbs around cities like Boston, Atlanta, Houston, and Los Angeles began to blossom with new office construction. Even Phoenix, which was devastated by the savings and loan crashes, increased its office occupancy rate from 70 percent in 1990 to almost 90 percent by the beginning of 1997.

The industrial segment likewise saw a great resurgence by 1997. Industries producing goods experienced a surprising rebirth during the economic upturn of the mid-1990s. As a result, demand for warehouses, research and development facilities, and similar facilities jumped. A new generation of investors emerged, including real estate investment trusts (REITs), which entered this market along with private investors, corporate owners of property, and pension fund investors. Dallas, Portland, and Chicago led in the warehouse market while the Sunbelt led the light assembly market, and Boston and Seattle led the research and development market. The trend was to larger, consolidated facilities, although many existing small facilities were taken over by start-up companies. Industrial parks also began to grow in both size and number.

The one segment unable to recover in the mid-1990s was the retail segment. Reasons for this depressed condition were numerous, including slow retail sales, retail bankruptcies and consolidations, poor management, overly leveraged investments, and a general oversupply of retail properties. Companies as diverse as Barney's and Caldor's reached a crisis point in 1996, although some chain operations such as Staples and Wal-Mart continued to prosper and plan for expansion. There was an increase in urban retail development because many suburban markets were overbuilt. The closing years of the 1990s saw even the retail segment of the nonresidential market sharing in the good times fueled by the long-running economic boom.

Data from the U.S. Bureau of the Census showed that lessors of nonresidential buildings generated revenues of more than $38.1 billion in 1997. The Bureau reported in its 1997 Economic Census that more than 31,000 establishments were actively involved in this market in 1997. They employed a workforce of 145,317 and had a total annual payroll of $3.8 billion.

The growing popularity of electronic commerce presented the nonresidential real estate market with new challenges as the new millennium dawned. It became increasingly clear that management companies would have to adapt to e-commerce to survive. Analysts predicted that for those who were quick to make the transition, the rewards would likely be stronger growth, increased market share, and new business opportunities. The key to success would be the ability to be more flexible, innovative, and nimble than their competitors.

During the early 2000s, a weak economy affected the commercial real estate market. Corporations scaled back employee rosters, cut back on spending, and delayed expansion efforts. As growing numbers of workers were displaced, consumers also delayed purchases as confidence levels fell. The industry did not, however, suffer the severe downturn that occurred during the early 1990s. Investment levels remained strong, as real estate provided better returns than many stocks. According to the April 2003 issue of Mortgage Banking, research from the CCIM Institute and Landauer Realty Group, Inc., revealed that commercial property investments reached their second-highest level in eight years during the third quarter of 2002, climbing to $13.79 billion. The number of transactions also reached near-record levels, climbing 33 percent from the previous year.

Overall, signs of recovery became evident in the last half of 2002, although some real estate segments fared better than others. Hit hardest was the office segment. While some analysts suggest that a vacancy rate of about 8 percent is manageable for this portion of the industry, Mortgage Banking reported that vacancies rose from 10.2 percent in the third quarter of 2001 to 15.1 percent a year later. Among the factors contributing to a slow recovery were rising property tax and insurance levels.

The industrial sector fared the best, according to Mortgage Banking. Vacancy rates increased from 9.5 percent in the third quarter of 2001 to 11.4 percent a year later. In early 2003 vacancies within the retail sector were approximately 13 percent, up from 9 percent a few years earlier.

One major development affecting the industry in the early 2000s was the terrorist attacks against the United States on September 11, 2001. Following the destruction of the World Trade Center in New York, insurance companies largely removed terrorism coverage from the so-called "all-risk" policies that cover commercial buildings. By early 2002, virtually no insurance companies offered coverage for terrorist acts, and those that did charged astronomical rates.

To address concerns within the industry, President George W. Bush signed the Terrorism Risk Insurance Act of 2002 into law on November 26, 2002. According to the U.S. Department of the Treasury, the legislation established "a temporary Federal program that provides for a transparent system of shared public and private compensation for insured losses resulting from acts of terrorism, in order to protect consumers by addressing market disruptions and ensure the continued widespread availability and affordability of property and casualty insurance for terrorism risk. In addition, it will allow for a transitional period for the private markets to stabilize, resume pricing of such insurance, and build capacity to absorb any future losses, while preserving State insurance regulation and consumer protections." In effect, this new law helped to alleviate fears about investing in commercial real estate ventures.

Spurred by historically low interest rates and a revived economy, the real estate market had regained its footing by the mid-2000s. "Retail real estate is hot," Beth Mattson-Teig noted in Commercial Investment Real Estate Magazine in June 2005, adding that "Large retailers continue to drive new development and investor demand remains near record highs." During 2004 mortgage markets rose to record levels. The Federal Reserve reported $2.29 trillion in commercial mortgage debt, up by $219.5 billion from 2003.

Office space transactions rose by 65 percent to $77.2 billion during 2004. After suffering significant losses in business during the early 2000s, office space was making a strong recovery during the mid-2000s, with growth estimated at 4.4 percent in 2005. The office space sector was led by the West and Northeast.

The retail space sector, which took a serious blow during the early 2000s with record vacancy rates, also showed strong improvement, fueled by double-digit growth in consumer spending. Although retail spending growth slowed during 2005, low interest rates made investment capital readily available for expansion as a means to increase revenues.

Industrial property vacancies were declining as well, falling to approximately 10.3 percent in 2004. The industrial sector, fueled by renewed growth in the warehousing segment, faced pressures from aging properties that were declining in functionality. Multifamily housing held steady with a vacancy rate between 6 and 7 percent. Low interest rates, which fueled the home ownership market, kept the multifamily sector from showing any significant growth.

Rental rates started to increase in 2005, driven by higher real estate taxes, electricity, and other operating costs. In 2003 national commercial rates averaged $42.66 per square foot, well below the high of $51.58 per square foot reached in 2000.

The overall real estate market was strong in the mid-2000s, and in 2005 the number of new housing starts in the United States hit a record 1.7 million, due to low interest rates and lenders' lenient credit requirements. However, many of these low-interest loans were based on adjustable mortgage rates, and as the lower rates expired and balloon payments came due, many who had purchased homes in the early and mid-2000s found they could no longer make their house payment. Housing prices took a nosedive, and the subprime mortgages that had been packaged and sold by lenders to investors on Wall Street were suddenly worth very little. By the end of 2009, scores of banks had lost too much money to keep their doors open, and the number of home foreclosures had reached record highs.

Current Conditions

Commercial real estate suffered along with the rest of the real estate industry in the late 2000s. According to Bloomberg news agency, commercial property values fell 35 percent between October 2007 and August 2009. As stated by Scott Lanman of Bloomberg, "That's making it tough for owners to refinance almost $165 billion of mortgages for skyscrapers, shopping malls and hotels this year, pressuring companies such as Maguire Properties Inc., the largest office landlord in downtown Los Angeles, to put buildings up for sale. "

The increase in unemployment during the recession also contributed to the drop in demand for commercial space. For example, according to the National Association of Home Builders, state and local governments alone eliminated 367,000 jobs between June 2009 and October 2010. University of Pennsylvania's Joseph Gyourko called job loss in America a "really significant negative fundamental" in the commercial property industry. The downturn threatened the more than 7,000 small lending institutions in the nation, where 47 percent of all loans were in commercial real estate in 2009.

The industry continued to struggle into 2010, and, according to Moody's, commercial real estate prices fell to their lowest point yet in August, down 7.6 percent for the year and down 45 percent from their peak in October 2007. Said Nick Levidy, managing director at Moody's, "Prior to 2009 there were only a few distressed sales and performing properties drove the CPPI [Commercial Property Price Index]. During the downturn, however, the number of distressed properties has increased, causing an increased weighting of the CPPI towards troubled properties that have had large negative rates of return." Fortunately Levidy and other industry experts predicted a recovery in the industry beginning in 2011, albeit a slow one.

Industry Leaders

In the shopping mall segment of the commercial property leasing industry, Simon Property Group, based in Indianapolis, was North America's leader in 2010. Its properties included the massive Mall of America in Minnesota and the Forum Shops at Caesar's Palace in Las Vegas. With 5,200 employees, Simon posted 2009 revenues of more than $3.7 billion. Simon owned and managed 320 properties totaling 250 million square feet in the United States as well as Europe, Japan, South Korea, and Mexico.

With 200 million square feet of leasable space, the nation's second largest owner/operator of shopping malls was General Growth Properties, Inc., headquartered in Chicago. In 2004 General Growth purchased The Rouse Company, a large real estate investor in its own right. General Growth, which employs a workforce of more than 3,200, posted 2009 revenues of $3.1 billion. The company struggled in 2009, however, when it faced $25 billion in debt and filed for Chapter 11 bankruptcy protection.

Other important players in the shopping mall segment of the industry included CBL & Associates Property Inc. of Chattanooga, Tennessee, and The Macerich Company of Santa Monica, California.

C.B. Richard Ellis Group, based in Los Angeles, was the world's largest commercial real estate services company with over 1.1 billion square feet under management and operations in 30 countries. The company reported revenues of $4.1 billion in 2009 and employed 29,000 people worldwide.

Based in New York, Cushman & Wakefield, was an another major global player in the commercial real estate services industry. Worldwide, the company managed more than 5,500 properties, totaling more than 300 million square feet, in 60 countries. Annual revenues for Cushman & Wakefield were around $800 million in the mid-2000s. Dallas-based Trammell Crow Co. was another one of the country's most successful commercial real estate management companies, with more than 500 million square feet under management in 2010. Employing 6,000, Trammell Crow posted annual revenues of about $780 million.

America and the World

In the late twentieth century, many American property owners and operators sought to enter potential growth markets in emerging European, Asian, and Central American countries. For instance, Trammell Crow Co., Tishman Speyer, and other large real estate firms pursued new projects in Berlin. Athens and Brussels also offered potential for U.S. investment in European properties. Mexico was another bright spot for U.S. real estate companies in the 1990s and 2000s. Markets in developing economic areas such as China, which had begun to liberalize its market structure, presented great potential during the mid-2000s.

The most significant international factor affecting property owners and operators in the United States was the renewed interest in foreign investment in U.S. real estate. Foreign investment bottomed out in the early 1990s, contributing to plummeting real estate values, which destroyed much of the equity that owners had in their properties. Although foreign investment peaked in 1990 at $34 billion, it fell to a fraction of that amount in 1991. The Japanese, for instance, invested $16.5 billion in U.S. real estate in 1988, compared with just $5 billion in 1991. Even a rise in the dollar against European currencies in 1992 was not enough to buoy the market for foreign capital. As the decade progressed, foreign investors became more interested in re-entering the U.S. market, particularly in suburban areas. For example, P.P.M. America, Inc., which is associated with Prudential of the United Kingdom, bought a 305,000-square-foot suburban Atlanta office building in 1996 for $32 million.

The North American Free Trade Agreement (NAFTA) and General Agreement on Tariffs and Trade (GATT) also affected certain U.S. industries. The textile industry in the Southeast was adversely affected when companies moved operations outside of the country and closed production facilities in the United States. New business, however, was being generated in cities bordering Canada and Mexico, such as Detroit and El Paso, thus increasing the need for nonresidential space.

By the mid-2000s foreign investors were scooping up commercial property in the United States. According to Real Capital Analytics, in 2004 foreign investment in U.S. real estate totaled $13 billion, up 60 percent from 2003. Leading investors included Germany, Australia, Canada, and the Middle East.

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