Real Estate Round Up with John Cognetti – September 17, 2011

John Cognetti speaks on Real estate Round Up September 17, 2011

Despite the setback of being denied KOZ status, much Mount Pleasant space (the finished building rendered above) has already been gobbled up by Physicians Health Alliance and Valley Oral and Maxillofacial Surgery.

Michelle Dempsey, principal with Dx Dempsey Architecture, says that one of the newest commercial structures in northeastern Pennsylvania (NEPA) is representative of the designs of the future.

The $6 million, 31,000-square-foot medical and professional center facility, known as the Mount Pleasant Corporate Center, is located at Linden Street and Seventh Avenue in Scranton. A product of Beacon Medical Real Estate in collaboration with Summit Associates of New Jersey, the project launched in 2008 after the acquisition of the property by the Scranton Lackawanna Industrial Building Company (SLIBCO).

Dempsey, principal architect for the job, explains that Mount Pleasant economically delivers Class A office space with an invigorating atmosphere and a design that is appropriate for the blooming NEPA market. The building sports a very functional interior with state-of-the-art medical technology and no waste.

“We made careful choices within a rightfully economical budget for Mount Pleasant,” says Dempsey. “The course of many new buildings in the future will undoubtedly be just like this one.”

Dempsey’s team secured the Mount Pleasant job by utilizing a professional network that included her engineering professor at Lafayette and an association with the Greater Scranton Chamber of Commerce. She also is excited about the strong possibility that a Mount Pleasant sequel will be constructed in the near future.

The building serves as a signpost for NEPA’s future in another way. All of the parties involved in the construction agree that the presence of The Commonwealth Medical College (TCMC) served as a catalyst for the economic growth needed to erect such a structure.

“The Mount Pleasant building is proof of TCMC’s economic impact,” adds Dempsey. “Beacon Medical also believes in the future of NEPA more than many of the people living in NEPA do.”

Tri-state activity

Victor Angeline III, principal with Beacon, points out that the company has erected 70 medical buildings during the last 20 years throughout New York, New Jersey, and Pennsylvania. The company still manages 35 of these projects.

He explains that Beacon and Summit, who have collaborated on two medical construction sites in New Jersey, quickly identified the Scranton region as fertile ground for a similar projects after TCMC became established. In short, the school and the region’s plentiful supply of regional hospitals added up to a good investment prospect.

“We see medical buildings as good returns, and have been very successful with buildings near medical campuses,” says Angeline. “We also like NEPA, and our faith became justified when 60 percent of the Mount Pleasant building was pre-leased.”
The Beacon success formula, which is incorporated into the Mount Pleasant site, includes leasing to only “solid” medical practices with relatively no out-of-pocket expenses and ample free parking for patients. Additionally, tenants may enter into a joint venture where the physicians can become part owners of the building.

Angeline also comments that the rental space at Mount Pleasant turned out a bit more upscale than originally intended.

“We believe in a stable construction environment, long leases and very flat long-term leases,” says Angeline.

As the Mount Pleasant project unfolded, Beacon did experience one major setback that eventually lowered the net rental income and decreased the job’s profitability. The Scranton School District, in somewhat of a surprise move, refused to extend Keystone Opportunity Zone (KOZ) designation to the site, thereby removing the building from a group that enjoys select tax benefits.

Angeline also confirms that the potential is strong for construction of another Beacon medical building in NEPA. He says the company is also looking at similar opportunities in cities like Carlisle and Lewisburg, but that obstacles, such as delayed leasing due to the economy and the unknowns from health reform, could serve as a brake to delay project launches.

“Our return to investors is typically about 8 percent to 10 percent, and Scranton, as a whole, has been friendly for our business,” says Angeline. “As TCMC grows, there will be a need for more medical facilities with turn-key construction.”

Healthy demand

Mike Detter, associate broker with Hinerfeld Commercial Real Estate, has been named the leasing agent for Mount Pleasant. He comments that demand for the building’s space materialized very quickly as the Moses Taylor Health System’s Physicians Health Alliance (PHA) grabbed 13,000 square feet of space and Valley Oral and Maxillofacial Surgery leased another 3,500 square feet.

Detter agrees that the presence of TCMC was a prime driving force behind Beacon’s involvement in NEPA. Other positives in the decision to build included the prime location, and the decision to create a very functional no-frills structure that would decrease the operating expenses of the medical practices who leased the space.
He also approves of Beacon’s business plan which offers the option of equity partnership for tenants. This practice is common within Beacon projects in New York and New Jersey, and many physicians have declared that they often prefer to own their space.

Detter identifies the loss of the KOZ exemption as the only real disappointment that occurred in the Mount Pleasant saga.

“When the school board shot down the request for a KOZ extension, it was unfortunate,” says Detter. “Yet, the project moved on, and there is great hope Beacon will create another similar project in NEPA.”

Automotive Distributing Co. of Tunkhannock purchased the 81,204-square-foot former yearbook publishing facility in the Scott Technology Park for $1.8 million.

Company President Raymond Bach said 21 employees will move to the newly purchased facility in late April with an eye toward hiring the additional employees by year’s end. Its current home at 189 East Tioga St. will be put up for sale.

Mr. Bach was sold on the building because of its condition and location.

“We have eight trucks that have to drive half an hour after getting off I-81,” he said. “This facility is two miles from 81. The savings in fuel and time alone will be great.”

Mr. Bach and co-owner Lannie Ross have decades of experience in the auto parts business but started this venture at the beginning of the recession.

“It was rough going, and we had to take market share from the competition,” Mr. Bach said. “Now, we see even more growth.”

Automotive Distributing has 14-acres at the Scott Technology Park. Mr. Bach said the company may consider acquiring adjacent land from the Scranton Lackawanna Industrial Building Co., the development arm of the Greater Scranton Chamber of Commerce, to expand the building in the near future. The Scranton Plan’s Kristin Driesbaugh helped negotiate the deal. Hinerfeld Commercial Realty of Scranton represented the seller.

“The building is adaptable to a variety of uses, including manufacturing and warehouse/distribution,” said Stephen Carroll of Hinerfeld. Another plus was the proximity of the building to Interstate 81.

Automotive Distributing Co. serves seven states.

Herff Jones closed in September, putting 100 out of work.

• the application on a large scale of securitization;
• the resulting influx of Wall Street capital into the US CRE markets, and the resulting easy credit;
• the increasing aggregation of CRE ownership into larger entities;
• the development of complex capital stacks at the individual loan level;
• the parallel development of complex tranches of debt at the loan pool level;
• the commoditization of real estate lending;
• the crash of real estate values when the real estate lending bubble burst;
• the ongoing clash between the regulations and assumptions governing Wall Street’s investments into CRE (through CMBS bonds) – based on securities laws – and those that govern real estate – based on traditional local real estate practices, and the inherent limitations on the uses and real value of real estate;
• the rise of the “BRIC” (Brazil, Russia, India and China) economies;
• the increasing concern over reducing carbon based fuel use and developing sustainable/green alternative energy sources and ways of doing business.

What do these all have in common? Virtually all of these disparate changes have been driven, at least in part, by the ever-increasing development and application of computer technology around the world and in our industry.

Very simply, computer technology – pronounced dead by some during and after the 2000 – 2001 tech crash – is bearing fruit in simple and complex ways, which are ultimately changing how everyone in the world does business, assesses risks, and understands the world – and is also changing the world of US CRE and (maybe) that last proud holdout, legal practice. 21^st Century technology may not be as glamorous as the jet-pack future we expected when I was growing up, but is every bit as disruptive as imagined, if not more so.

First, the rise of the BRIC economies. Computer technology has spurred globalization.

The ability to use the Internet to communicate across time zones, and for computerization of design and product development from computer chips to movies to engineering services has allowed multinational corporations to profit from arbitraging the costs of labor (and the equally important, but frequently hidden, costs of environmental regulation) around the world. (It has also radically shortened delivery times and improved inventory management for most businesses.)

This movement of manufacturing, and some services, to less developed countries has led to the development of huge educated classes in the BRIC countries yearning only for a chance to make it – and a corresponding flight of jobs from more developed and expensive Western countries to the BRIC and other lower cost countries. Those jobs created huge aspiring middle classes, all seeking to emulate the developed countries’ standard of living. Their demand, in turn, has spurred huge internal growth in the BRIC countries.

This has led to tremendous demand for raw materials, and likely will also lead to huge demand for energy, food and manufactured objects, as even more people worldwide seek to improve their standards of living. These trends, along with the ability of more and more people in our service economy to work remotely, is also changing – and likely lessening – the demand for CRE in the US, and also is changing how commercial real estate will be used in the future.

Second, the growing interest in renewable energy and sustainable ways of living and doing business comes partly from the rise of the BRIC economies. And part of it is motivated by a desire for energy security: simply put, we’ve fought too many wars for oil – we must develop a better alternative so we can no longer be held hostage by our energy demands.

But additionally, the interest in all things green has increased over the last 10 years because there’s more and more data available – and more of it can be collected, collated, and processed – with the help of computers – so that meaning can be derived from the amorphous blobs of data. This information is making it harder to ignore the impacts of humans (and our massive population growth) on the natural world.

(The idea that one should clean up after oneself and not pollute thoughtlessly, or not create – or applaud – a wholly disposable material culture is not a new one: my Depression survivor aunts, raised on a Midwestern dairy farm, had what can only be described as a family mantra, repeated to all of us cousins as a quasi-religious guide to life: “Use it up, wear it out, make it do or do without”, which seemed wildly old fashioned – even dowdy – to my modern suburban know-it-all self in the 1960′s and 70′s. Funny how right they were, and how old ideas come back into vogue. But I digress.)

Finally, all the changes we’ve seen in the CRE finance world resulting from the influx of Wall Street money, including the bubble in real estate values caused by easy credit and the resulting crash, are related to each other – and to the increasing use of computer technology.

Without the ability to crunch large amounts of data concerning the default rates and other financially relevant information, the promoters of securitized loans could not have developed persuasive models for the likely risks of default for the various tranches of their loan pools.

Essentially, these models treated each piece of real estate as if it were made up of a set of basically fungible variables that, when abstracted, would perform like any other piece of real estate that had the same variables. That’s essentially an abstract, “securities” outlook.

By contrast, a more traditional “real estate” outlook evaluates each real property as unique: for example, assessing whether a given retail corner is worth more or less than the other three corners, depending on whether it is on the “going home” side or on the “going to work” side of the street. While the truth likely is somewhere in the middle (pieces of real estate may not be absolutely unique, but are not as easily comparable and predictable as the Wall Street models hold), the abstract securities view of real estate requires numerical assessment of large quantities of data about large numbers of buildings in order to develop believable – and saleable – models on which investors would base investment decisions. (Of course, as with all models, the assumptions made in the models drive their ultimate accuracy, and the current rise in default rates demonstrates how difficult it is to account for all possibilities in such assumptions.)

The trend is for more and more development of computer programs to allow people to do things they want to do more easily and quickly, and at a lower cost. Obviously this trend has radically changed property management and portfolio management; I expect over time it will even creep into the practice of law, driving greater efficiencies in the production of documents. (It has done so to some extent to date, but frequently badly for a number of reasons, often resulting in expensive litigation.)

I expect we’ll see much more of an impact on commercial real estate demand and use in the US as more computer programs drive more efficiency throughout every business that is a user of real estate – and every business process.   I hope we’ll get collectively a lot smarter about understanding what computers do well, and do poorly, so that we can make more critical evaluations about the models – and their conclusions – on which we build our own business models.  Hang on tight  - I expect the next 10 years will be as wild as the last, as our industry must respond to these global changes.

*Source GlobeStreet.com

The 30,800 square-foot state-of-the-art medical and professional office building features great accessibility with abundant free on-site parking. It’s located less than five minutes from local hospitals and equity partnerships are available.

Right now, Hinerfeld can offer:

• Aggressive rents;
• Landlord to provide turn-key build-out of space;
• Space planning to custom design your suite;
• We’ll pay half of your Mercantile Tax for the original lease term; and
• One month of free rent for each year of the original lease term.

The Scranton-Lackawanna Industrial Building Co., which is the development arm of the Greater Scranton Chamber of Commerce, sold the lot to the Linden, N.J.-based Beacon for $792,000.

The chamber argued unsuccessfully before the Scranton School Board during the summer to garner Keystone Opportunity Zone status for the business park, which would have given developers a 10-year real estate and state tax forbearance. The park is on Linden Street, the former site of the Keystone Block Co.

In the end, the draw of the Commonwealth Medical College outweighed the economic hit from losing the tax incentive, said Beacon partner Daniel Siegel.

“We had this property under contract, and we were extremely disappointed,” Mr. Siegel said. “But we think there is a need for a facility like this in Scranton. So we have to work harder.”

The medical school will prompt an expansion in the medical sector and demand for high-quality office space, Mr. Siegel said. The building will be all-steel construction, brick clad, with a porte-cochere, gurney-sized elevators, energy-efficient windows and mechanicals, and about 130 parking spaces. The groundbreaking will be in November, and the building will be ready for occupancy by the spring of 2011, Mr. Siegel said.

Beacon has been involved with the development of 1.5 million square feet of space in New York, New Jersey and Pennsylvania. Tenants can receive a share of equity in the property, becoming partial owners of the building.

Chamber President Austin Burke said he’s grateful Beacon stuck with the project, but said the lack of economic incentives to offer prospective employers will mean that it will take longer to fill the other four or five lots at the business park.

“We will be successful in bringing in new employers, but it will take longer,” he said.