Powerless: Feeling the Heat?

Commercial pros say clients won't suffer much from energy woes spreading around the country.

June 1, 2001

What starts in California usually spreads, and the energy troubles of 2001 are no exception.

Analysts are warning of California-type problems--brownouts and escalating utility prices--in major metro areas throughout the country this summer.

What will that mean for the nation’s commercial practitioners? Some extra client hand holding but no extreme measures, say California pros who’ve been there.

“The state’s energy problems have trickled down to the commercial real estate markets here,” says R. Marty Smith, executive vice president of Coldwell Banker Commercial-Almar Group, Temecula, Calif. “But energy won’t be the straw that broke the camel’s back. There’s been some pullback, but at the end of the day, people know our energy problems are solvable.”

The tone is similar in other metro areas, even those expected to be hardest hit by energy woes, such as New York City. The main reason? Continued strong market fundamentals and the untarnished attraction of the cities.

Utility prices more than doubled in parts of California in the spring, according to reports. This summer that same volatility is expected in New York and Chicago, among other places, thanks to the same confluence of forces that have rocked California: escalating demand, slow approval for new plants, and deregulation.

Other areas that will most likely see utility trouble are the Pacific Northwest, parts of Minnesota, and several Southern states, including Arkansas and North Carolina, according to analysts.

In the short term, property owners are protected. Most of their contracts with tenants are structured as triple net leases, so all occupancy costs are passed on to tenants.

But that protection becomes a liability if utility prices rise so high that tenants start eyeing outlying areas with lower utility costs (and lower rents and taxes).

As a rule of thumb, commercial tenants are comfortable with utilities at 4 percent to 5 percent of costs, says Jack Guttman, principal managing director, Coldwell Banker Commercial, North East Realty Advisors, New York City.

If those percentages double, companies could well look at relocating, but practitioners say they aren’t expecting any kind of mass exodus from hard-hit areas.

“When you look at the mix of company costs, electricity remains one of the smallest pieces of the pie,” says Paul Fetscher, CCIM, president of Great American Brokerage, New York City, a restaurant specialist.

“If a tenant’s utility bill doubles from 4 percent to 8 percent of costs,” he says, “that’s still just an increase of 4 percentage points.”

In key metro areas such as Los Angeles and New York City, the most important factor for real estate, according to Fetscher, is the area’s centrality to the region’s population base.

Smith agrees: “From a manufacturer’s perspective, the priority is to get products to consumers at the least cost. That means being where the people are, even if energy costs are rising in that area.”

One of Smith’s clients, a lawn-equipment manufacturer, moved forward on plans late last year to consolidate three San Diego plants into a single Los Angeles site because the latter location is where the company’s long-term growth is. “The company wouldn’t move to, say, Phoenix despite rising utility prices here,” he says. “When you factor in all the costs of reaching customers, the rising energy costs are a wash.”

But staying put doesn’t mean companies are without tools for combating rising costs, and that’s where commercial practitioners can add value.

Top among them is identifying redevelopment and empowerment zones within the metro area, because they offer relocation incentives, including reduced utility bills.

“Those zones are really a good alternative for many companies,” says Guttman. “Nobody ever thought energy costs would be a focal point of the zones, but they’ve become that.”

The zones typically provide a mix of federal, state, and local incentives, including tax breaks, grants, and low-cost loan funds, to relocating companies. The goal is to spur private investment in the areas. In New York City zones, utility costs can be 30 percent less than in nontargeted areas. The incentives typically last three to five years.

For companies that own their own buildings, sale-leasebacks are another tack. “We’re promoting sale-leasebacks because they enable companies to turn their assets into cash at a time when that’s increasingly important,” says Smith. What’s more, if they negotiate a gross lease, they can hand utility costs over to the new owner.

Conservation also remains key. Building owners and others have created ad hoc consortia to share best practices for lowering commercial property energy consumption.

The real estate community is also offering suggestions for getting new supply. In New York City, an alliance of real estate interests issued a white paper in early 2001 that contains proposals for generating new supply.

The bottom line? As energy problems spread to other parts of the country, property owners and tenants will feel the impact, but the higher costs are eminently manageable. “After 32 years in commercial real estate, I’ve heard all the threats, including higher energy prices,” says Fetscher. “This, too, shall pass.”

Robert Freedman

Robert Freedman is the former director of multimedia communications at NAR.

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