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.
711310 (Promoters of Performing Arts, Sports and Similar Events with Facilities)
531120 (Lessors of Nonresidential Buildings (except Mini ware houses))
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. By 2002 conditions had begun to gradually improve. However, a number of analysts argued that a full recovery was not likely until the mid-2000s or later.
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 General Motors or IBM, which operate properties that serve their core businesses.
Specialization. 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 under-standing 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 as the developers to which they loaned money during the 1980s 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 currently 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 Institute of Real Estate Management, which includes both residential and nonresidential real estate, also provides educational services such as property manager certification and began establishing international partnerships with developing nations in the mid-1990s.
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 the twentieth centuries, and were mimicked in America as early as the seventh 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 has been the emergence of social control, which has limited the freedom of property owners to use and develop land in a manner that does not serve the public good. Social control has 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 American 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 profits continued to grow at a brisk rate, often averaging more than one 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 has traditionally been driven by the amount of capital available to fund new projects, rather than by market demand. This phenomenon is largely a result of favorable tax laws that have 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 midand 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 the 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 during 1984 to 1989 of one 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 newer 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 were exerting 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 different segments: the office segment, the industrial segment, and the retail segment. Of the three, the office and industrial segments made great strides toward recovery; 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 are lower, traffic and parking are less troublesome, and safety and quality of life are 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; the "Sunbelt" led the light assembly market; and Boston and Seattle led the research and development market. The trend was toward larger, consolidated facilities, although many existing small facilities were being 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: 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 expansions. There was an increase in urban retail development because many suburban markets had become 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 had 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. Fortunately, the industry did not 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 within 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 third quarter 2001 to 15.1 percent a year later. Estimates from Chicago-based Real Estate Research Corp. (RERC) projected that rates would likely reach 18 percent by the end of 2002, and then remain between 17 and 18 percent during 2003. The office market was not expected to improve significantly until about 2006. 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 , and was expected to recover more quickly as general economic conditions improved. Vacancy rates increased from 9.5 percent in the third quarter of 2001 to 11.4 percent a year later. In early 2003 it was estimated that vacancies within the retail sector were approximately 13 percent, up from 9 percent a few years earlier. Because of a weak retail sales forecast, this segment of the industry was expected to improve slowly through 2004 as vacancy rates moved toward the 10 percent mark and rent levels gradually increased.
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.
Among the major players in the nonresidential real estate market in the early 2000s were Simon Property Group, Inc. (formerly known as Simon DeBartolo Group); the Rouse Co.; General Growth Properties, Inc.; Trammell Crow Co.; and Kimco Realty Corp.
Simon, based in Indianapolis, is North America's largest operator of shopping malls, including among its properties the massive Mall of America in Minnesota and the Forum Shops at Caesar's Palace in Las Vegas. With 4,020 employees, Simon posted 2002 revenues of $2.4 billion. Another major force in the retail real estate market is Rouse Co. of Columbia, Maryland, which has been responsible for the development of such retail centers as Faneuil Hall Marketplace in Boston and New York's South Street Seaport. As of 2002, Rouse employed 3,453 workers and reported sales of $1.1 billion.
The nation's second largest owner/operator of shopping malls after Simon Property Group, General Growth Properties, Inc. is headquartered in Chicago. The company, which employs a workforce of more than 3,800, posted 2002 revenues of $1.1 billion. Dallas-based Trammell Crow Co. is one of the country's most successful commercial real estate management companies. With more than 7,000 employees, Trammell Crow posted 2002 revenues of $653.6 million. Kimco Realty Corp., headquartered in New Hyde Park, New York, had interests in nearly 500 properties in 41 states as of early 2003. Kimco reported 2002 sales of $557.1 million.
In light of the global slowdown during the 1990s, 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 American investment in European properties. Mexico was another bright spot for American real estate companies early in the decade. Markets in developing economic areas such as the former Soviet Union and China presented great potential during the early 2000s.
The most significant international factor affecting property owners/operators in the United States was the decline of foreign investment in U.S. real estate, which began in 1991. This contributed 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, has been generated in cities bordering Canada and Mexico, such as Detroit and El Paso, thus increasing the need for nonresidential space.
Brown, Steve. "Looking Ahead: Challenges Coming for Commercial Real Estate." Dallas Morning News, 25 December 1998.
Creamer, David E. "Terror's Economic Impact on Commercial Real Estate." American Banker, 5 April 2002.
Hoover's Online, 1999. Available from http://www.hoovers.com .
"Investors Show Confidence in Commercial Real Estate." Mortgage Banker, April 2003.
Kane, Carl. "2000 & Beyond: Oldies But Goodies." National Real Estate Investor, 30 September 1999.
Riggs, Kenneth P., Jr., and Del H. Kendall. "A Hopeful (Yet Sobering) Commercial Real Estate Outlook." Mortgage Banker, January 2003.
Ross, Stan. "2000 & Beyond: Making the 'Offer.' " National Real Estate Investor, 30 September 1999.
U.S. Bureau of the Census. 1997 Economic Census. Washington: GPO, 1999.
U.S. Department of the Treasury. Office of Domestic Finance. "Terrorism Risk Insurance Program." 16 April 2003. Available from http://www.ustreas.gov .
Valley, Matt. "Forecast 2003." National Real Estate Investor, 1 December 2002.
"With Help from Congress, Commercial Real Estate Will Continue to Stimulate the Economy." Buildings, March 2003.
Comment about this article, ask questions, or add new information about this topic: