The first year under tax reform may very well become the year of the big switch for commercial building developers.
Elimination of tax incentives for office development, coupled with the existing backlog of ample office space almost everywhere in the nation, strongly suggests that developers and their cohorts will and must seek new markets.
An era of transition is in the offing as the building industry makes its adjustments to comply with the new tax laws, starting Jan. 1.
Commercial realty leaders, their advisers and management staffs convened in Chicago last month to ponder the forthcoming changes and to hear some of their peers discuss the outlook and their collective futures.
Howard Ecker, president of a Chicago-based realty firm bearing his name, predicted a recession in the commercial office market, which is headed, he said, "for a short-term depression." But he quickly offered seven construction markets as potential areas of interest for the industry.
"Rather than relying on winning the few major office building projects that will go forward in some markets, commercial developers will be better advised to target their marketing efforts at segments of the (construction) market that will grow during the period of transition," he advised.
These markets are:
Banking and finance, expanding because of the national bank movement.
Legal services and accounting fields, which expand in times of economic change.
Office modernization, as the best structures of the 1960 and 1970 decades upgrade to compete with newer buildings.
Interior construction, as vacant structures start filling up and large tenants opt to remodel rather than relocate.
State and local government are both learning that the public is willing to be taxed for some services formerly provided by the federal government.
Regional and foreign markets, including the strongest cities in the nation and abroad.
John Cushman III, president of Los Angeles-based Cushman Realty, keynote speaker at the conference sponsored by Builder magazine, acknowledged that office building developers and their investors will proceed very cautiously now. This attitude will result in reducing the high vacancy rates in many of the nation's overbuilt cities, he added. Like Ecker, he believes that there will be growth in the office market from an expansion of professional firms. "The law firms and Big Eight accounting firms are just exploding. The general service sector will continue to be what makes our business expand."
Claude Ballard, a partner at Goldman, Sachs & Co., foreseeing a decline in building starts because of reduced tax and economic motives, said, "The new tax law takes billions of dollars out of the corporate side and puts it in the hands of the consumer. As a result, the corporate side is going to have less incentive to expand then they have had in the past. This could constrain the demand for office buildings, as well as the supply."
But they generally agreed that demand for space next year will continue strongly in such major centers as New York, Boston, Washington, Chicago and Los Angeles.
The building executives expect their greatest competition will come from Japanese investors who find it highly profitable to invest in commercial real estate in the United States because the value of the yen is extremely strong against the American dollar.
Cushman reminded the conference that the Japanese are the dominant buyers of commercial real estate in Los Angeles and he believes they will soon move into development of projects, through joint ventures initially, and then independently.
Ballard added that the "conventional wisdom that the Japanese are only interested in the West Coast is not true. They'll buy in any good U. S. city," he said.
What's more, he quipped, "With the current exchange values, the Japanese can make an investment mistake of about 30% and still come out with a profitable transaction."