Retail is one property sector that never has time to rest on its laurels. As they battle the lingering effects of the recession and increased online shopping competition, retailers are once again shifting store strategies.

The steep economic downturn forced many retailers to clean house by eliminating underperforming stores, upgrading locations, and taking a hard look at their broad approach to future growth. The chief task going forward is how to squeeze more efficiency — namely lower costs and higher sales — out of brick-and-mortar stores in a world where online shopping is rapidly increasing.

“I think that the number of stores are going to be reduced, the size of the stores is going to be reduced, and the operating functionality of the stores is going to increase,” says Henry Englehardt, CCIM, a senior vice president at Colliers International in Walnut Creek, Calif.

Big-box retailers are already shrinking store footprints to reduce expenses. “Office supply stores were the first, but now you see retailers across the board looking to reduce their store footprints,” says Chad Gleason, CCIM, a principal at Real Estate Investment Services in Kent, Wash. Big boxes that currently occupy 20,000 square feet to 25,000 sf are looking to slim down to 12,000 sf to 15,000 sf. “It is a big chunk of real estate, and you have to pay that bill every month,” he adds.

Big-box retailers are also using smaller footprints to access urban markets. Target, for example, plans to expand its new urban prototype in 2012. The urban stores range between 60,000 sf and 90,000 sf — half the size of a typical suburban store. Walmart is also looking for new locations for its neighborhood grocery, which, at 40,000 sf, is about one-fourth the size of its superstore format.

Bricks and Clicks
Retailers are challenged with the task of transforming strategies and operating models into a “store of tomorrow” to attract greater customer loyalty and a larger share of customer spending. Certainly, brick-and-mortar retailers are doing everything they can to embrace the high-technology shopper, working to combine the in-store experience with the convenience of online shopping with either direct delivery or in-store pick-up.

But online retail continues to exceed sales growth from traditional brick-and-mortar channels at an alarmingly high rate. In fact, the average growth rate of online sales has been about 20 percent annually, while the growth rate for traditional retail sales is averaging about 3 percent per year, according to a 2011 retail study by Deloitte Consulting.

The good news for brokers and investors is that brick-and-mortar retail stores are not going the way of the dinosaur. But retailers do recognize the importance of adapting store strategies to meet the demands of a changing retail environment. “The forward-thinking retailers and merchandisers are partnering and figuring out how to get more efficiency out of the existing bricks and mortar,” Englehardt says. Many retail executives believe that the role of the physical space is shifting from a transactional model to an experiential one, in which customers have a personalized experience with the brand. In fact, 85 percent of retail executives polled in the Deloitte retail study indicated that providing customers with a compelling brand experience will become a store’s primary role in five years.

As such, retailers are looking at innovative changes to draw more people into stores, such as expanding on the store-within-a-store concept, notes Englehardt. Although this concept has been around for years, retailers hope that partnering with the right brand will create more buzz and help draw added customer traffic. Sears is leasing 43,000 sf inside its high-performing Costa Mesa, Calif., store to teen clothing brand Forever 21, a prototype arrangement that, if successful, could be repeated in other markets. Target is partnering with Radio Shack to house 1,500 mobile phone stores, and is reportedly working on a deal with Apple for in-store kiosks.

Signs of Life
Other retailers have remained active throughout the recession, notably discounters such as Family Dollar, Dollar General, and Ross Dress for Less. The wireless stores fueled by AT&T, Verizon, and Sprint have also continued to aggressively roll out new stores. “There are a number of small shop retailers that are actively looking and transacting deals. The challenge is that they are all chasing the best sites,” says Jonathan E. Lindsey, CCIM, a broker with The Shopping Center Group in Birmingham, Ala.

Fast-casual restaurants are another active segment of the market. For example, Lindsey represents Smashburger, which recently executed the brand’s first lease in Alabama with a location in Madison. The restaurant group is looking for multiple locations in that market, and may open as many as 10 new locations in central and northern Alabama over the next five years.

Entrepreneurial growth is driving retail activity in areas such as the Rio Grande Valley in Texas. Operators that have a franchise or license agreement with brands such as Domino’s, Cash America Pawn, and T Mobile are looking for space. “We’re still having a hard time getting out leases that need a finish-out allowance, because everybody is still cash poor,” says Cindy Hopkins, an independent broker and owner of HCRE in Harlingen, Texas. “But I think franchisees have a more active outlook and want to make things happen in 2012.”

Activity is coming from the mom and pops who have either retired or been laid off and now want to open up a store, agrees Gleason, who serves clients in the secondary and tertiary markets outside of Seattle. “A lot of these new entrepreneurs are going into older, second- or third-generation space in smaller downtowns on short-term leases and having success with it,” Gleason adds.

Backfilling Empty Space
Across the country, many markets are still working to backfill vacancies left when large category killers such as Borders, Circuit City, and Linens N Things closed hundreds of stores. In addition, many cities have been hit by the loss of local and regional players. For example, Bruno’s Supermarkets closed more than 60 Bruno’s and Food World stores across Alabama and Florida.

Empty big-box space has created attractive opportunities for retailers that are jockeying for position in top markets. The greater San Francisco Bay Area has virtually no big-box vacancy, as new retailers entering the market have snapped up space. Sprouts Farmers Markets, Fresh & Easy, and Hobby Lobby — “those retailers have stepped up very aggressively and picked up some of the vacant space,” Englehardt says.

Fitness centers also have been expanding in northern California. Engelhardt represents Safeway, which has closed a number of its stores as the chain consolidated. Brands such as LA Fitness and 24 Hour Fitness have been very interested in leasing those spaces, which typically span about 28,000 sf.

Other markets have seen creative re-use of vacant big-box spaces. For example, one opportunistic local investor in Alabama converted a more than 40,000-sf Bruno’s Supermarket into a climate-controlled self-storage facility. That investor is looking at similar conversion opportunities throughout the Southeast, notes Lindsey. Other empty big-box stores are being carved up to create multitenant space. For example in Jasper, Ala., a former 48,000-sf Food World store has been re-configured to house tenants that include a new Goody’s, Hibbett Sports, and a thrift store.

Big boxes aren’t the only empty spaces seeing creative re-use. “Many office users are still using retail space for their general office requirements — mainly due to the lack of available office space, or the cost associated with finishing out new offices,” adds Hopkins. Finish-out costs for office buildings outweigh the cost for retail space in the Rio Grande Valley.

Recession Rebound
The retail real estate sector was hard hit by the economic downturn, leaving hundreds of store closings and major bankruptcies in its wake. But current industry data is pointing to a market that has stabilized and is on a tentative cours e for recovery.

The net absorption of retail space for 2010 and 2011 was a combined 119.9 million sf — nearly triple the amount of new construction that came online during the same period. That absorption has helped to reduce vacancy rates 50 basis points to 9.7 percent at year-end 2011 and vacancies are forecast to improve further to 9.2 percent by the end of 2012, according to Marcus & Millichap.

The retail picture is improving, but those gains are not even across the board. Markets vary widely depending on the specific economies and dynamics within local markets. There continues to be a big divide between the A locations and older B and C properties. Top malls, luxury retail stores, and well-located grocery-anchored shopping centers, as well as wholesale clubs and off-price outlets have outperformed the general retail market.

All 44 markets tracked in Marcus & Millichap’s National Retail Index are expected to post job growth, vacancy declines, and effective rent growth in 2012. However, certain geographic markets are bouncing back faster than others. San Francisco, San Jose, Calif., and Seattle ranked as the top three cities in the index. Those top cities are bolstered by technology, a strong outlook for job and population gains, as well as tourism growth. At the bottom of the index are markets that are still struggling such as Jacksonville, Fla., Cleveland, and Detroit.

“Retailer activity is not nearly at the pace that existed in 2006 and 2007, and in many ways, that is good,” Lindsey says. The aggressive expansion that was occurring during the peak of the market led to overbuilding and poor decision-making for many retailers and developers. The retail activity that has emerged today is driven by a more-conservative, strategic approach.

Retailers that are in expansion mode are highly focused on strategic growth that makes sense, which is why there is heightened competition for top locations, he adds. “The constant rule of location, location, location is valued even more.”

Beth Mattson-Teig is a business writer based in Minneapolis.

Appetite for “A” properties
Buyers may not be venturing too far out on the risk spectrum. Yet the rise in sales volume over the past year is an added vote of confidence in the retail market recovery.

Investors continue to favor “best in class” retail properties. Grocery-anchored centers and “A” credit single-tenant properties such as Walgreens are widely sought after. “Those single-tenant deals are very much in demand. There is much more demand than there is supply right now,” says Jason Donald, director of retail brokerage services at Cushman & Wakefield of Florida, in Tampa, Fla.

Despite a third-quarter pullback in buying activity, retail property sales totaled $42.4 billion in 2011 — a 91 percent increase in volume over the prior year, according to New York–based Real Capital Analytics, the largest gain of all the property sectors. Major metros continue to generate the most transactions; the top five most active markets by volume for retail sales include Manhattan, Los Angeles, Boston, Chicago, and Atlanta.

Investment continues to trickle down to secondary markets such as Charlotte, N.C., Nashville, Tenn., St. Louis, Atlanta, Birmingham, Ala., and Tampa. “Capital has started to find its way into these smaller markets, be­-cause what you would pay for one property in New York, you can potentially capture two or maybe three properties in the Southeast,” Donald says.

For example, Cushman & Wakefield is working with a private buyer based in Manhattan that is selling off some existing properties and reinvesting that money in Florida, because he feels that the market has hit bottom and there is some upside. “Like most, he is looking for a deal,” Donald   says. The buyer is looking at single-tenant and multitenant properties, as long as the amount of small shop space is not greater than the anchor tenant.

“The retail market does offer plenty of opportunities for today’s investors, particularly if the buyer has a tenant in tow or excellent tenant relationships and has the horsepower to hold, market and re-fit, and lease,” agrees Tom Hill III, CCIM, owner of Tom Hill Realty & Investment in Waterbury, Conn. Grocery-anchored or national pharmacies such as CVS and Walgreens are generating low capitalization rates of 6.0 percent to 7.5 percent, while non-anchored centers are seeing cap rates upward of 10 percent and are not moving quickly. “There are lots of bargains, but you need all cash to get one, and many buyers with cash want huge discounts due to the re-leasing risk,” Hill adds.

It has become increasingly evident to those in the commercial real estate industry that improving building energy performance and making other sustainable and green improvements can impact property values and balance sheets. To some degree, building owners find themselves caught in a ‘Catch 22′ situation. On one hand, buildings that are slow to adopt these changes and implement green retrofits and more efficient operations are seen as being at a competitive disadvantage in the market. On the other hand, lenders willing to finance such green improvements are few and far between.

How do stakeholders in this profit-driven industry go about financing these building improvements in an uncertain economy?

Energy Efficiency Retrofit Financing Options

A recent report issued by Anthony J. Buonicore, PE, BCEE, QEP, managing director at Buonicore Partners LLC, entitled, Energy Efficiency Retrofit Financing Options for the Commercial Real Estate Market, cites the lack of commercially-attractive funding as a major impediment to energy efficiency investment in the CRE market. A recent McGraw-Hill survey confirmed that building owners seeking to pay for energy retrofits for their properties often are forced to rely on resources from the internal balance sheet rather than outside funding.

Buonicore reiterates what owners have been saying to lenders for years, “To really move this market, there is a clear need to make energy efficiency financing a mainstream financial asset class with a high degree of standardization, predictability and scale.”

“Ideally,” said Buonicore, “such funding should come without any capital expense, without adding debt to the property, will cover the entire cost of the project, contain favorable tax deductions for the expense, and present favorable terms with low rates and extended repayment periods.” Does everyone have their magic wands ready?

Despite the dearth of mainstream financing, Buonicore surveys the financing options that have sprung up for retrofits and finds a surprising number are able to meet many of the ideal criteria outlined above, no magic needed.

In addition to internal and debt financing, these mechanisms include lease/lease purchase agreements, ESCO (energy service company) financing, energy service agreements, government loan programs, PACE (property assed clean energy) programs, and on-bill utility financing.

In identifying the advantages and drawbacks associated with each and with several energy efficiency underwriting options, it’s clear that Buonicore’s main contention that making energy efficiency financing a ‘mainstream financial asset class’ remains an elusive goal.

Editor’s Note: Financing Green is a three-part series taking a look at energy efficient retrofit financing options, the role of data in overcoming the uncertainty of financing green improvements, and real-world examples of funding green improvements for the tenant or end-user.

Financing Building Energy Efficiency, Overcoming Uncertainty

At the Second Annual Conference on Sustainable Real Estate hosted by NYU Schack Institute of Real Estate, a panel confirmed the scarcity of financing available for green building improvements.

The discussion was led by moderator Susan Leeds, CEO of New York City Energy Efficiency Corp. The panelists included: Caroline Blakely, vice president multifamily risk with Fannie Mae; Greg Hale, senior financial policy specialist with the Natural Resources Defense Council; Sean Neil, managing director of Transcend Equity; and Arah Schuur, director of the energy efficiency building retrofit program with the Clinton Climate Initiative.

CRE lenders and banks understand commercial real estate and the risks involved – after all they’ve been making loans collateralized by commercial property for years. But for many lenders, green is a new thing, one that doesn’t fit neatly into underwriting programs that often require years of data for evaluating risk and assessing the long-term financial impact from investments.

In addition to looking for the costs versus the savings of implementing green improvements, lenders also are looking for more historical data documenting the increased rent income or increased property values that can be expected from such investments. Numerous studies have shown that Energy Star and LEED-certified buildings can attract higher rents and generate increased demand from tenants, which can lead to higher income and sale prices. However, lenders want to see more actual data instead of projected results, panelists noted. Policy data and market performance are also important assessments for lenders to consider in evaluating a specific project.

As a means for side-stepping the issue until more definitive data to satisfy lenders is available, panelists cited one option that may work in the current lending environment, and that is for building owners to roll the cost of green improvements into an ongoing building retrofit or repositioning. That way, panelists said, owners may overcome lenders’ reluctance to consider green improvements as a stand-alone investment.

The panelists noted that financing for green improvements should become more available as more historical performance information is standardized and analyzed. They acknowledged that vast amounts of data are currently being collected on countless green improvements for commercial real estate buildings, such as the energy savings of light sensors or LED lighting, or the cost savings of using low-flow fixtures in restrooms, and even the environmental and employee health impact of clean air technology.

However, they also cited several challenges associated with the data being collected. One problem they identified is that different entities are collecting the information using different criteria and methodologies, which make it difficult to make valid comparisons between data sources.

Another issue is that the collected data can quickly become obsolete as newer and more advanced technologies are released into the marketplace. Often these newer technologies do not have the testing or data available that banks and lenders would like to see in order to make proper assessments on the risk versus the reward of implementing such improvements. For example, 10 years of performance data doesn’t exist for a brand new solar panel or light sensor.

The panelists cited the importance of collecting data, and aggregating and presenting it coherently as critical to getting money flowing for green improvements. Only then will lenders, building owners and related parties be able to review the available options, analyze the execution process, and then look for optimal financing options.

In his keynote address, Richard L. Kauffman, senior advisor to the secretary, Department of Energy, introduced several themes that would be repeated in the panels to follow that day, including that big banks are unlikely to, and perhaps should not, provide financing for green improvements, which are too small and risky. Instead, owners should be looking to capital market investors, state bonds, local banks and government incentives to pull together the necessary capital for individual green improvements to their existing commercial buildings. He also cited points often brought up between lenders and stakeholders in the green improvement industry, namely the need for more metrics, empirical data on risks, and actual cost vs. performance data, not just promises of what a new technology can be expected to deliver.

There are signs of an improved outlook in certain economic areas where franchises are traditionally strong performers, such as the restaurant and business and personal services industries, according to the International Franchise Association (IFA) and GE Capital Franchise Finance.

The IFA released its first quarterly update to its economic outlook prepared by IHS Global Insight in December 2011. IFA is updating its Franchise Business Economic Outlook on a quarterly basis this year instead of just an annual outlook.

The IFA analysis is based on a grouping of franchise businesses in 10 broad business lines. The growth outlook differs among the groups, with output growth in 2012 ranging from 6% in personal services to only 3.7% in retail food.

And in a separate report, GE Capital Franchise Finance also said the restaurant industry is starting to heat up again.

While providing a positive outlook in general, the revised IFA forecast is down slightly from the original forecast of 1.9% three months ago. The IFA now indicates that the number of franchise establishments in the United States will increase by 1.6% in 2012.

“Our forecast of the number of new businesses to be created economy-wide has been reduced slightly and with it expectations for growth of the number of new franchise establishments,” the IFA said.

Since our December 2011 forecast report was prepared, there have been a number of positive economic releases,” said James Gillula, managing director at IHS Global Insight, IFA’s partner in compiling the forecast. “However, negative factors that could restrain an economic rebound remain.”

On the plus side, there have been three successive employment reports showing over 200,000 new jobs per month – which point to the possibility of a more sustained economic recovery.

However, negative factors that could restrain an economic rebound remain. Gasoline prices have risen sharply, creating a drag on consumer demand, and weak global growth limits the possibility of gains from rising exports, the IFA said.

Business services will rank first in franchise employment growth at 3.3% and third and fourth, respectively, in growth of the number of establishments and employment.

In addition to being the growth leader in output, personal services will rank second in growth of the number of establishments and third in employment growth.

Quick-service restaurants – the largest franchise business line – will rank fourth in the growth of new establishments but will see growth rates of output and employment that are near the franchise sector average.

Franchised real estate operations are also expected to show some signs of life this year, as well, the IFA said.

“We expect sales of new homes to increase by 17% in 2012. Sales of existing single-family homes, coops and condos are expected to be up 10%,” the IFA forecast. “On the non-residential side, vacancy rates for retail, commercial, and industrial properties remain high by historic standards, but have been coming down as the economy continues to gain ground. There are some signs of life on the new construction front as well. The percentage gains we anticipate in 2012 will look impressive, but will leave the industry still well below its pre-recession level.”

Within the retail sector, the fastest growth will occur among non-store web-based retailers.

“Long-suffering building materials, furniture and home furnishings, and electronics and appliance retailers will finally have something to cheer about in 2012,” the IFA said. “Among general merchandise retailers, warehouse clubs and superstores and dollar stores will lead the way. Traditional department stores are likely to continue to lose ground as consumers continue to favor lower prices.”

Employment in franchise establishments in 2011 was revised up slightly to show a 2% gain. The IFA continues to expect 2.1% employment growth in 2012. The output of franchise establishments in nominal dollars in 2011 was revised down slightly to show a 4.9% gain. The IFA continues to expect 5% growth in 2012.

Restaurant Industry Starts to Simmer

Meanwhile, consumers are spending more on meals, and foot traffic at establishments is improving, albeit from a diminished base, according to GE Capital’s Chain Restaurant Industry Review, released this week.

As sales trends recover, operators are translating those positive feelings into a greater willingness to invest in their businesses. And with increasingly accessible credit, they’re able to commit to higher capital expenditures.

“The restaurant industry has come through the upheaval of the past several years by listening closely to the consumer and adapting to their changing tastes – and they’ve done it well,” said Agustin Carcoba, president and CEO of GE Capital, Franchise Finance. “Depending on their segment, brand and focus, operators have emphasized food quality, service quality, menu options and other factors that will lead to renewed growth this year and in the years ahead. Even better, operators did it all while managing operational costs.”

Consumers spent $406.6 billion at restaurants in 2011. For 21 consecutive months, they spent more at restaurants than grocery stores, and that trend is expected to continue, GE Capital said.

Last year, quick-service restaurants (QSR) accounted for 48% of that figure, and full-service restaurants (FSR) accounted for 48.1%. The QSR category includes limited service, fast casual, take-out locations and snack and non-alcoholic beverage bars, while FSR includes family, casual, high-end casual and fine dining establishments.

Operators’ improved expectations can be partially attributed to positive results that were sustained throughout last year. QSR same-store sales grew 3.2% last year – ahead of the FSR rate of 2.4%. QSR benefitted from eight consecutive periods of growth due to more consistent traffic, while FSR relied more on menu price increases and higher average checks.

“Restaurateurs are no longer in survival mode; now they’re planning for the future,” said Trey Brown, commercial leader of GE Capital, Franchise Finance. “To capture that growth and maintain a competitive advantage, they’re investing in their businesses by building new stores, remodeling existing ones or investing in new equipment.”

The level of liquidity available in the restaurant space continues to improve. Merger and acquisition activity – an indicator of the popularity of the restaurant industry among investors – increased last year. Total syndicated volume in the restaurant space increased more than 26% to almost $12 billion in 2011.

Strategic buyers returned, such as American Blue Ribbon Holdings LLC, Darden Restaurants and Landry’s Inc. Private equity firms were also active; for example, Golden Gate Capital acquired California Pizza Kitchen.

“We expect restaurants to continue to be appealing acquisition targets because of the ongoing increases in food dollars spent away from home, as well as the scalability of this business model,” Brown added.

Prepare for the smaller (and smarter) corporate office.

Corporations around the globe have been holding on to office space in anticipation of a market rebound, but that’s about to change. “A growing number of corporate property owners say they have up to 50 percent excess leased office space,” according to Jim Young, CEO of RealComm, a commercial real estate and technology advisory firm. “Their goal over the next five to seven years is to eliminate that excess space.”

That “50 percent” figure might be shocking, until you reflect on recent changes affecting corporate office space usage. In the first 10 months of 2011, employers announced more than 520,000 planned job cuts, according to outplacement company Challenger, Gray & Christmas. While well below recession levels, this figure marks an increase of 16 percent over the same period in 2010.

At the same time, technology continues to reshape corporate office culture. Those who keep their jobs are now more likely to work outside the office, at home, or at client sites. According to Teknion’s recent Workplace of the Future study, 46 percent of companies surveyed currently employ cloud computing — which allows employees to access company data from any computer — and 90 percent plan to increase their investment in productivity-enhancing technology by 2015.

Thus, when it comes to corporate office space usage, bigger is no longer better. At November 2011’s CoreNet Global Summit in Atlanta, Peter Miscovich, managing director of corporate solutions for Jones Lang LaSalle, predicted that by 2015, the average square footage allocated per employee will shrink by up to 75 percent, depending on the industry sector.

The new paradigm is “smaller and smarter,” Young says. But less space means smaller and possibly fewer leases. If portfolio managers and brokers hope to compete in the changing corporate real estate landscape, they need to understand how companies are preparing for tomorrow’s office.

Sharing Space
What does tomorrow’s office look like? According to Johnson Controls’ recent study Collaboration 2020, during the next decade employees expect to spend less time at their desks and more time working in dedicated collaboration rooms and communicating via video conferencing.

Many companies have already begun to implement what is perhaps the most striking innovation: shared seating. Some prefer a reservation-less hot-desking arrangement, while others use hoteling, which requires employees to reserve unassigned seats. Either way, “the idea of an office where you can hang pictures of your family and display your sports trophies is a thing of the past,” Young says.

This change seems to be a natural outgrowth of the increased popularity of mobile technology. According to an international workplace study by Cisco, three out of five workers say they don’t need to be in the office to be productive anymore. With a laptop, tablet, smartphone, or some combination of those devices, many office employees can work anywhere they can get online.

This also means that time spent in the office is often dedicated to meetings and other face-to-face activities rather than sitting at a desk. According to the Workplace of the Future survey, 77 percent of corporations are already utilizing more open, collaborative workspaces and fewer individual offices.

Ryan M. Lorey, CCIM, director of global real estate at Booz Allen Hamilton in McLean, Va., recently coordinated his company’s move from two buildings totaling approximately 750,000 square feet of old, inefficient office space in Tysons Corner, Va., to newly designed buildings with shared seating. “Our 15-year lease terms were coming up, and the buildings’ heating, ventilation, and air conditioning and other infrastructure were reaching the end of their functional economic life,” Lorey says. “All of the new buildings were designed for maximum efficiency, with more collaboration space and a hoteling environment, so eligible employees can work where they need to, when they need to.”

Technology is also helping corporations redefine their office space utilization. “We are implementing alternative work environments in every new project,” says Dennis Virzi, CCIM, a senior portfolio manager with AT&T in Dallas. “By deploying high-speed Wi-Fi and Follow Me telephone services, we can offer a functional workplace at approximately half the footprint of a traditional cube layout.” Virzi’s company is currently in the process of eliminating an expensive lease. Using only technology enhancements, they plan to accommodate 150 employees at a new location that has only 85 workstations.

Other corporations are finding shared-seating opportunities and collaboration space in their current portfolios. Liam Murphy, CCIM, of Hayes Commercial Group in Santa Barbara, Calif., recently worked with a client who began using offices previously reserved for traveling executives to accommodate hot-desking. “Now they are able to fit more of their regular staff into the corporate office without taking on more square footage,” Murphy explains. When the economy bounces back, corporations that recognize these opportunities will be able to expand without leasing additional space.

At What Cost?
But as full economic recovery continues to recede into the distance, most corporations are still focused on cutting costs rather than expanding payrolls. The key to reducing costs associated with a leased office portfolio is also one of the keys to creating a smaller and smarter office: Study occupancy needs. A careful analysis is almost certain to reveal excess space that can be shed or used more efficiently.

“Gone are the days when brokers and real estate directors can use generic formulas to calculate occupancy needs,” says Andrew Harnish, CCIM, director of enterprise development for Johnson Controls in Seattle. “In today’s global, virtual, and dynamic workplace, we need to analyze how people work together, where they work together, when they work, and the frequency of their desk and conference room usage.” This process might involve interviews, direct observation, or the installation of temporary motion sensors that track space usage. “Though this seems like an expensive study, the cost is very little compared with the inefficient space being paid for over the life of a lease,” Harnish adds.

A shared-seating setup can also give companies more information about their workforce and how they utilize office space. At Booz Allen Hamilton, employees must reserve a space, with a five-day max per reservation. To get metrics, Lorey collects data from the online reservation system. Though the results are still preliminary, he expects the company will reach 80 percent utilization after all of the renovations are complete.

Johnson Controls recently worked with a global company that transitioned to a shared-seating arrangement for several reasons, including cost. The company reduced its carbon footprint by nearly 20 percent, resulting in an annual savings of more than $3 million. Another client that made this transition was able to reduce infrastructure needs by 15 percent, Harnish says.

“It is always more efficient to consolidate,” says Stuart L. Rosenberg, CCIM, SIOR, president of ICI Commercial in Arlington Heights, Ill. “Typically, utility costs can be cut just by reducing the amount of exterior wall space exposed to the elements.”

Corporations that aren’t ready to consolidate should consider taking advantage of today’s rent rates to prepare for tomorrow’s office. “Open a dialog with the landlord for a blend and extend,” Virzi says. “Market rent rates are down and most owners are eager to extend lease terms. B&Es are also a good way to obtain fresh tenant improvement funds, which takes the pressure off corporations’ operating budgets for things like new carpeting, paint, and landscaping.”

Murphy suggests incorporating early termination or “buyout” language into every new lease, as it saved one of his clients hundreds of thousands of dollars. For example, a seven-year lease might have a termination option after the third year. “The end result is that corporate users do not have to absorb the risk of subleasing if their demand for space changes suddenly,” he explains. “Most of our buyout clauses end up being a penalty of 10 percent of the remaining lease liability, which ensures that the landlord is compensated for unamortized TIs and brokerage commissions.” Tenants have the option to terminate, and landlords get an extra check.

Other consolidation and expense-reducing opportunities are out there, but small companies may not have the resources to discover them. In that case, Murphy says, “Copy the big guys.” Most Fortune 1,000 companies hire consultants or create full-time positions to identify and implement these strategies, and small companies can borrow and apply the strategies that work for them. For example, as a branding tool, companies such as Cisco and Intel release white papers that outline their sustainability efforts. Other companies publish their criteria for landlord vendors, which might include a list of specific tenant improvements. “Best practices are best practices,” Murphy adds, “no matter who discovers them.”

Rich Rosfelder is associate editor of Commercial Investment Real Estate.

Changing the Corporate Culture
Proposed FASB rules could have unintended consequences.

The single most important change of the proposed Financial Accounting Standards Board lease accounting standards would be eliminating the distinction between capital and operating leases. Under the proposed guidelines, companies would be required to recognize every leasehold obligation (in excess of one year) on its balance sheet.

But will that change the way corporations make their real estate decisions?

As part of our graduate thesis project at the Massachusetts Institute of Technology Center for Real Estate, we interviewed representatives from 29 companies to answer that question. We conducted targeted interviews with a diverse sample of companies representing tenants, landlords, and other industry professionals, from both the public and private sectors.

We concluded that the proposed changes in lease accounting would not cause an industry-wide shift in corporate real estate strategy. However, for those companies that value the accounting impact of real estate decisions to a greater degree, the proposed changes could be a catalyst for changes in real estate behavior.

The impact for a particular firm would be largely based on two main factors: the size of a company’s operating lease portfolio relative to its balance sheet and a company’s sensitivity to financial statement presentation.  These factors make a company more likely to change its behavior to mitigate the effects of the proposed changes.

We also discovered through our research that the proposed accounting changes would require companies to incorporate sophisticated lease tracking systems in order to comply with the new reporting requirements.  For example, since a balance sheet entry for a particular lease could change over the lease term based on the likelihood of certain events (such as the exercise of a termination or renewal option), more analysis and more communication between internal departments would be required. For instance, corporate real estate groups would need to discuss transactions with corporate finance and accounting groups.  As a result, companies would scrutinize their real estate footprint in greater detail and have a greater awareness of any inefficiency in the space they occupy. Companies would be better equipped to make real estate decisions that would lead to increased efficiency in the market.

The Government Development Bank-Economic Activity Index for December 2011 showed its first year-over-year growth since March 2006 at the start of Puerto Rico’s years-long recession, officials announced Monday.

The GDB-EAI hit 127.7 in December, a 0.5% increase over the previous December, officials said.

Citing the GDB-EAI’s 98% degree of correlation with real gross national product levels, officials expressed hope that after a stabilization period of more than a year, the Puerto Rico economy is finally breaking into positive terrain.

Total payroll employment, one of four components comprising the GDB-EAI, hit 934,600, a 0.2% improvement over the year-prior period and the first month reflecting positive growth since early 2006.

Cement sales, another GDB-EAI indicator, totaled 1.618 million bags in December, a 13.9% increase over the same period in 2010. Total cement sales for calendar year 2011 ended 5.4% above 2010.

Meanwhile, gasoline consumption reached 95.3 million gallons in December, an increase over the average 87.1 million gallons consumed monthly during 2011, according to GDB officials.

Only one of the four indicators — electric power consumption ― declined compared with last year, with December consumption registering a 1.7% decline over the same period the previous year.

The positive year-over-year growth follows three straight months in which the GDB-EAI showed month-to-month improvements, and in November it fell a mere 0.1% when compared to the year-prior period. However, the December performance of 127.7 was actually a slight decrease from the 128.2 registered in November.

There are other indicators that the economy is on the rebound, notably the unemployment rate dropping to 13.2% in December, the lowest rate since January 2009. Car and home sales and manufacturing production have also been on the rise, while bankruptcies are finally retreating.

Nevertheless, the most recent figures could well spell the best economic news since the recession began nearly six years ago in March 2006. If the year-over-year growth keeps up for the next few months, it would mark the end of the recession. A widely used definition is that a recession begins after two quarters of economic decline, and ends after two quarters of growth.

The Federal Reserve this past week issued aggressive and controversial recommendations for dealing with more $7 trillion in housing wealth loss since the onset of the Great Recession. Many economists agree that housing holds the key to a stronger and more widespread recovery in the U.S., and the Fed’s recommendations are intended to address the buildup of surrendered and foreclosed housing inventory that continues to dampen consumer confidence.

The Federal Reserve’s commentary this past week in a white paper, “The U.S. Housing Market: Current Conditions and Policy Considerations,” recommended policies that would limit the growth of the inventory of foreclosed homes, make mortgage credit easier to access and limit the flow of homes into foreclosure.

Fitch Ratings says the Fed’s recommendations face challenges, but may benefit the private-label residential mortgage-backed securities (RMBS) sector. The primary recommendation of the white paper is a government-facilitated REO-to-rental program, either through direct rentals or third-party sales.

“Expanding the options available for holders of foreclosed properties to dispose of their inventory responsibly could reduce the number of distressed sales and the effect of those sales on home prices,” Federal Reserve Governor Elizabeth A. Duke told the Virginia Bankers Association last week.

“For example, in many housing markets the demand for rental housing is much stronger relative to supply than in the market for owner-occupied homes. Reducing some of the barriers to converting foreclosed properties to rental units will help to redeploy the existing stock of houses in a more efficient way,” Duke said.

“Along the same lines, aggressive neighborhood stabilization efforts, including transferring low-value properties to public or nonprofit entities, such as land banks, that can manage properties that are not dealt with adequately through the private market, could lessen the effect of foreclosures on the prices of homes in the surrounding neighborhoods,” she added.

In analyzing the recommendations, Fitch Ratings reported this week that “while we believe this idea has merit, as it could potentially reduce the number of distressed properties for sale, it would face some operational challenges. A direct rental program could be an undertaking of some magnitude and cost for an REO holder due to the staffing and property management demands associated with large-scale property rental programs.”

“While a third-party sales program could minimize these direct costs, an investor’s ability to secure financing and the lower bids for bulk REO present a different set of challenges,” Fitch Ratings said. “Lastly, a program subsidy may not be politically well-received if it were to lower the recoveries otherwise achieved through sales to owner-occupants.”

Somewhat less challenging, from Fitch Ratings’ viewpoint was the recommended expansion of a program that would allow Fannie Mae and Freddie Mac to refinance underwater borrowers who are current on their mortgages.

“The potential default and loss exposure to the private-label RMBS would be significantly reduced by such a program,” Fitch Ratings said. “But this may be the most politically unpalatable of the recommendations as it would increase the credit risk exposure and size of the GSEs’ balance sheets.”

So if REO to rental is flawed and expanding refinancings is political suicide, what’s to like?

Fitch Ratings said a third recommendation calling for the increased use of foreclosure alternatives, such as short sales and deeds-in-lieu, is one that it believes may be the easiest to implement as it has already been put into practice by most servicers for some time now.

“Furthermore, we find that these alternatives have lower loss severities relative to foreclosures as they reduce the need for legal procedures and lower the cost to protect, maintain and broker the property,” Fitch reported.

“Overall we believe these recommendations could be a net positive for private-label RMBS because they would primarily reduce distressed housing inventory and some could lessen the downward pressure on prices,” Fitch concluded.

Fed Governor Duke told Virginia bankers that “policies that increase credit availability for homeowners or investors seeking to purchase a home or to refinance an existing mortgage would allow more borrowers to access lower interest rates and thus improve the transmission of monetary policy to the economy.”

“Renewed attention to a broad menu of options to modify existing mortgages would provide aid to struggling homeowners and would help to reduce the flow of foreclosed homes into distressed inventory,” she added. “When foreclosure cannot be avoided, incentives provided to homeowners that encourage short sales and deeds-in-lieu of foreclosure can reduce the time and costs of foreclosure and minimize negative effects on communities.”

In a trend that may bode well for a broadening recovery in CRE markets, small business owners are feeling more optimistic — or at least less pessimistic — about sales, hiring and expansion prospects over the next three to six months, according to the latest national index.by the National Federation of Independent Business (NFIB).

The NFIB Optimism Index rose 1.8% in November, with small business owners anticipating improved sales, hiring and capital spending amid a ‘less negative’ outlook for business conditions over the next three to six months.

Eight of the 10 index components improved or remained unchanged in this month’s report, based on the responses of 781 randomly sampled small businesses in NFIB’s membership surveyed throughout November.

While encouraged by the results, the advocacy group was careful not to portray the report as unrealistically sunny during a time of continued difficulty for many small businesses struggling in the tepid recovery.

“The numbers have been depressing for so long, any little progress looks good,” said NFIB Chief Economist William Dunkelberg, who co-authored the monthly Small Business Economic Trends report with policy analyst Holly Wade. Dunkelberg noted that the November reading is still “eight huge points” below its pre-2008 average and 14 points below the comparable recovery period in 2001.

A seasonally adjusted 7% of owners are planning to add jobs over the next three months — a four-point improvement over the previous month and the strongest reading in 38 months — although the number should be at double-digit levels in a solid economic recovery.

“Optimism appears to have climbed because fewer owners expect business conditions or sales to be worse in six months, indicating some hope on the horizon,” the NFIB said. “Improvement, although small, was widespread, with the forward-looking components indicating positive trends for the first time in many months.

“Still, our current reality is still very much the ongoing economic winter.”

The sentiment of small business owners contains much significance for commercial real estate and its investors, as more than 70% of job growth is generated by companies of less than 1,000 employees. The health of smaller businesses is an important factor in office and retail market fundamentals, particularly occupancies and rental rates in non-investment grade properties.

Those non-investment grade properties are starting to stabilize as their tenant base begins to gradually recover from the recession. The CoStar General Commercial Index, derived from repeat sales of non-investment quality properties, increased by 1.4% in October — the sixth straight month of rising prices since the general property index reversed 32 months of price declines dating back to September 2008, according to the latest CoStar Commercial Repeat Sale Index (CCRSI).

Accordingly, with smaller tenants and mom-and-pop retailers finally seeing light at the end of the tunnel, the level of distress sales as a percentage of total general commercial property sales has fallen from a high of 33% in March 2011 to 24% in October 2011.

In the office market, leasing trends also reflect the improved financial position of those tenants, many of which delayed or canceled business expansions or lease extensions. CoStar data shows that smaller tenants have returned to the marketplace over the last year. As of the third quarter, more than half of all new leases signed during the previous 12 months involved smaller tenants, while large office tenants occupying over 25,000 square held steady at 6% of new office leases.

Smaller businesses have been slower to recover in part due to excessive leverage and lack of access to capital. Smaller businesses have had more difficulty securing credit, unlike large corporations and REITs, which have very good access to capital. Nearly half of small business owners own their business premises and 39% own investment real estate, increasing their debt levels and hampering their ability to invest directly in their business.

The percentage of owners planning capital outlays in the next three to six months rose 3 points to 24% in November, according to the NFIB, the highest reading in 40 months. But it’s still 5 to 10 points below expected levels in a growing economy. Despite improving conditions, just 8% described the current period as a good time to expand facilities — still very low, but only a point below the best reading over the past 38 months.

Access to credit markets did not appear to be a concern among the NFIB respondents, with just 3% reporting financing as their top business problem — far below weak sales, and excessive taxes and regulation — and 93% reporting that they either have adequate credit or don’t need to borrow.

However, traces of concern about creditworthiness are embedded in the survey findings. One-quarter of the owners reported that weak sales ruled out investment in new equipment or new workers because they’re not likely to generate enough additional earnings to repay loans required to finance the expansion. The average reported interest rate on short-term loan maturities of 12 months or less was 6.3%, basically unchanged since 2008 in spite of the Federal Reserve’s efforts to lower lending rates for small firms.

“The weak recovery provides little incentive to borrow to support expansion or buy new equipment, even if interest rates are low,” NFIB said.

El Departamento de Agricultura (DA) continúa trabajando para cumplir su compromiso de incentivar y desarrollar la agricultura en la Isla.

Para este nuevo año, la agencia se trazó como objetivos la implementación y funcionamiento de varios proyectos, realizando importantes asignaciones en diversos sectores.

Como parte de las iniciativas de las Unidades de Calidad y Alto Rendimiento (UCAR), y con una asignación de 4 millones de dólares, el DA comenzará un proyecto piloto para cultivo de vegetales en un ambiente controlado, que permitiría una calendarización adecuada de las siembras.

A su vez, dicho proyecto reduciría los costos en el control de plagas. “Para hacer posible esta iniciativa, se está trabajando en la creación de 10 estructuras de una hectárea de terreno cada una. Su propósito es establecer tecnología que sirva de escudo contra los efectos de la copiosa lluvia experimentada en la Isla y de las plagas que afectan las plantaciones”, señaló el secretario de Agricultura, Javier Rivera Aquino.

Las mejoras a la planta de Carbonato Calizo es otro de los proyectos en los que trabaja esta agencia. Gracias a una asignación de $750 mil se podrá automatizar el proceso de ensacado y paletización del producto. “De esta manera, se podrá aumentar el volumen del mismo ya que a través de este proceso se enmienda el suelo esencial para la absorción adecuada de nutrientes”, indicó Rivera Aquino.

El aún titular de la agencia sostuvo que también se realizará una inversión de 1 millón de dólares en la Indulac para que cumpla con su función como planta de balance y elabore productos lácteos, tales como queso, mantequilla y yogurt, y de esta manera evitar el decomiso de leche que sufrimos el año pasado.

El Departamento de Agricultura cuenta con, aproximadamente, 20 proyectos listos para inaugurar en Puerto Rico, entre los cuales podemos destacar el molino de alimentos pecuarios Bobby Miller, iniciativas de placas solares y la granja avícola Pujols.

Walmart’s announcement to shift seven of its stores to a 24-hour schedule and confirmation of its $200 million local expansion plans help set a more positive tone for the retail industry in 2011.

Overall, year-end sales will improve modestly, by 3% to 5% as forecast by CARIBBEAN BUSINESS (CB Nov. 3). An early start to the holiday retail season, more precise inventory forecasts, adequate retail mix, aggressive pricing and attractive payment plans, including layaway, are among the measures that will yield positive yearend results for retailers.

With estimated combined sales of $3.5 billion from its local Walmart, Sam’s Club and Amigo supermarket stores, Walmart neared completion of the new Sam’s Club on Kennedy Avenue and broke ground on its multilevel Walmart Supercenter store in Santurce, both of which are in San Juan.

Accounting for 15 million square feet of the island’s retail space, the shopping center segment was a bit of a battlefield in 2011, with ongoing legal action between Empresas Fonalledas, owners of Plaza Las Américas, and developers of the $294 million Plaza Internacional project, Century Development and Taubman Centers. Venezuela-based Grupo Sambil’s proposed $414 million shopping center in Guaynabo didn’t escape Empresas Fonalledas’ wrath, either.

This year’s new arrivals included: PetSmart, T.J. Maxx, Victoria’s Secret and Steve Madden. New dining offers include Texas de Brazil, Teriyaki Xpress, Buns the Burger Shop, DiYukas, Casa Lola and the reopened Mango’s. It was cold war between frozen yogurts, with Yogen Früz and Yogurt Fit ahead of the pack.

Still, 2011 wasn’t kind to more than 100 restaurants that had to close this year.

Meanwhile, closing of bankrupt Borders Books Music & Café stores unleashed a bidding war for the prime Plaza Las Américas locale, with mall owners outbidding a couple of local hopefuls for the 30,000-square-foot space.

The island’s $6 billion food industry saw its sales dwindle as a result of the island’s ongoing economic situation and continues to battle the local restaurant industry over the distribution rules and regulations of the $2 billion federal Nutrition Assistance Program.

On the pharmacy front, CVS drugstore chain continued with its $400 million expansion, while industry leader Walgreens, with more than 110 locations, followed suit with the opening of a new store at Santurce’s Stop 18 and the addition of grocery departments to as many locations as would accommodate them.

Small retailers saw signs of improvement, said Ignacio Veloz, president of the United Retailers Association, based on new marketing strategies, becoming partners with other retailers and identifying new export markets.

He added that hundreds of Puerto Rican companies generated more than $143 million in new sales through their participation in some 14 national and international export events this year.

It was another fl at year for the local $900 million beer industry, despite new arrivals including Cervecera de Puerto Rico’s Magna; MillerCoors’ Blue Moon and V. Suárez’s new distribution of Brooklyn Beer.

While Ponce’s Destilería Serrallés is still gunning for a larger slice of the island’s rum-incentive program, Florida-based Caribbean Distillers introduced Roberts Spiced Rum, a runner-up contender to Captain Morgan, whose production moves from Serrallés to the U.S. Virgin Islands next year.

Puma Energy continues to expand its footprint in the Caribbean with the acquisition of Chevron’s fuel distribution and storage assets in Puerto Rico and the U.S. Virgin Islands. The deal will boost it network of gas stations in Puerto Rico to nearly 350.

Puma, unit of Europe-based commodities trading giant Trafigura, will buy Chevron’s fuel marketing and aviation businesses in Puerto Rico and the U.S. Virgin Islands for an undisclosed sum, the company said in a release.

The assets include 192 retail service stations, an aviation fuel supply business in the Virgin Islands, and storage tanks in Puerto Rico and St. Thomas, whose total capacity is around 430,000 barrels.

Chevron has sought a buyer for the assets since earlier this year, Puma said, adding that it has plans to expand the facilities once the deal is approved by regulators.

Swiss oil company Puma Energy Caribe has been building its fuel distribution business in the Caribbean and Latin America since 2010. It opened its first gas stations in Puerto Rico after buying Caribbean Petroleum Corp.’s (Capeco) fire-damaged depot in Bayamon along with 147 Gulf-branded service stations through a court-ordered bankruptcy sale. Puma has also acquired storage and fuel distribution from Exxon Mobil throughout Central America.

Puma is considering an initial public offering of stock within the next 18 months, and expects to have revenues of $4 billion this year, Reuters reported.

U.S. oil major Chevron announced in June it was leaving Puerto Rico and planned to sell its 187 Texaco stations across the island.

The Texaco brand has been in the U.S. Caribbean territory since 1911, and it currently has 75 employees.

Last year, the company issued a statement saying it would sell its fuels marketing and aviation business in other Caribbean islands including Barbados, Antigua and Martinique to Vitogaz SA., a subsidiary of France-based RUBIS.

The restructuring is aimed at saving money and strengthening more lucrative markets, the company has said. Chevron is based in San Ramon, California. Texaco became a wholly owned subsidiary of Chevron in 2001.