Creative Sector Real Estate in a Period of Economic Decline
By Jeremy Nowak, President and CEO, The Reinvestment Fund
January 23, 2009
How will arts and cultural organizations fare in the current economic climate and what are the specific challenges and opportunities as it relates to the acquisition and development of arts based real estate? What follows are a few ideas intended to create a dialogue around these challenges and opportunities.
Economic Downturn
America is experiencing a dramatic economic downturn. Today’s recession will last longer than others during the past fifty years and it may very well be deeper. We don’t yet know whether unemployment will reach double digit levels as it did 25 years ago, but it is possible.
Our economic woes have been facilitated by a meltdown in financial services; brought on initially by the bursting of a housing bubble, which in turn revealed problems in how we manage, regulate, save, and invest capital.
We see the results everywhere: stock market declines, lower real estate prices, increased business and personal bankruptcies, unprecedented numbers of foreclosures and household debt, almost daily actions by the Federal Reserve and Treasury Department to stabilize capital markets, and low consumer confidence that shows up in sharp declines in retail sales.
Management Challenges and Public Ambition
All parts of the economy are affected although some – financial and professional services, real estate, manufacturing, and retail – are in more rapid decline. To some extent educational and medical services are relatively cushioned, although that may change in the future. And of course, the nature of the economic crisis plays out differently depending on what part of the country you reside.
The decline in public sector revenue is leading to cuts in arts and cultural budgets. Investment losses within institutional and foundation endowments diminish the available pool of operating support. Some of the public and philanthropic cuts will not take full effect for six-to-twelve months depending on the timing of budget cycles. Philanthropic responses are varied but with losses in balance sheets ranging from 20-40 per cent of assets, the nonprofit funding community is undergoing a crisis in confidence and strategy.
There is no easy management solution to the problems of funding cuts. Every entrepreneur and nonprofit organization has a distinct financial situation; they vary in their capacity to make budget cuts without harming core products or diversifying their funding base.
The general management responses are commonsense: create efficiencies wherever they can be found; use the crisis to eliminate the legacy programs you wanted to, but couldn’t bring yourself to act on in more stable times; preserve competencies and brand while seeking diverse funding; identify ways to collaborate so as to share fixed costs with other institutions; and place speculative ventures on hold until better times.
Management advice aside, this is no time for the creative sector to be shy about its economic value. We have been making the case for several decades about how arts and cultural activities have direct and indirect economic benefits through place-based amenities; commercial and housing investment, educational advancement, and the role of creativity in the design, production, and circulation of global commodities.
On the eve of a Federal stimulus that will take many local twists and turns, we should make the case for our inclusion as an important economic sector, just as every other sector is doing. This is a time for management caution, but not for public timidity. It is a time for greater ambition about our public and private importance. Civil society and small business have received no federal bailout; yet they are vital to economic growth and recovery. Public infrastructure investments have implications for creative sector activities. Done the right way, this could represent a remarkable opportunity for public art investments.
Real Estate Decision-Making
What are the issues to keep in mind while making decisions regarding real estate acquisition and development for the creative sector – performance space, artist work space, live-work space, culturally driven community centers, museums, and related venues. I would keep four issues in mind and determine how to best apply them to your situation:
- Know your market!Real estate markets vary from region to region. Despite national trends there are wide variations in real estate performance, depending on the region of the country in which you reside. Some markets that were the most speculative are still falling and will experience more deflation. Other areas were never as overbuilt and overvalued and therefore are somewhat stable. The declines in value and the imbalance between supply and demand are one thing in Nevada and Southern California and another thing in Austin, Texas or Kansas City. Some downtowns continue to thrive with relatively low vacancy raters and others are shedding leases quickly and are home to partially built condo towers that are about to go into foreclosure.
- Be prepared for a new financial environment! The changes in the banking environment and credit markets are dramatic. It is now more difficult to obtain financing and harder to float tax exempt bonds. Many of the largest banks are not extending new credit and all banks have become more conservative in terms of underwriting. Better appraisals and environmental studies, stronger revenue and credit documentation, larger equity requirements on the part of the buyer, and more restrictive operating covenants are commonplace. Banks are wary of placing new real estate loans onto their balance sheets in uncertain markets, especially if they do not know if they will be able to sell the asset onto a secondary market. And they are very nervous about the income of potential borrowers at a time of economic uncertainty. Even the large cultural institutions with established banking relationships may find difficulties. There are, however, opportunities with smaller regional and community banks, community development financial institutions, and public sector entities able to float bonds. The Reinvestment Fund recently used some of its New Markets Tax Credit allocation to support the capital expansion and development of several arts groups. Similar uses of that credit and the low income housing tax credit (for artist housing) are happening around the country and need to be encouraged.
- Buyers and renters are in the driver’s seat! This is a great time to be a buyer or renter in most markets. In situations where there is too much real estate inventory or where commercial vacancies are on the rise, the consumer or buyer is in control; that is if you have the cash or credit standing to buy or rent. But as credit markets loosen up (and they will eventually) and as cultural institutions become more familiar with a wider range of investment credits, there are great opportunities. The caution for buyers is that they may not know if the value of the property will decline further. If you plan to stay in the property for a long period of time, this may not matter as much. This is also a great time for renting with the potential to lock in long term leases at good prices, and the potential to lock in options to buy at a later date. A note of caution, however: Weak markets get populated by desperate ‘dealmakers’. You need to always determine whether the seller or landlord can make good on their end of the bargain. In a buyer’s market you get to more thoroughly underwrite the seller and landlord.
- Strength in demand! There are new opportunities for the arts and culture sector to organize around space needs at a time when the supply of real estate far exceeds market demand. In times of uncertainty the kind of space that many artists seek can be extremely attractive to builders and owners. Artist work and performance space is relatively simple and cost-effective to build and convert in comparison to other uses that demand more finished space. Many cities and towns are filled with partially rented and partially sold (and in many cases partially built) commercial and residential buildings. The ability to understand local arts demand creates market power. Local trade groups or other networks can convert this knowledge into a negotiating platform with owners and builders looking for tenants and buyers.
This is a difficult time for many arts and cultural organizations to keep basic operations going and in many cases, the last thing they need are new cost burdens or new risks associated with a real estate venture. At the same time, there are some intriguing, yet contradictory, forces at play that create opportunity.
While the risk adverse and nature of the credit markets can make purchases difficult, this can be the ideal time (from the perspective of price and choice) to enter into a long term lease or buy a building. It is also easier to get competitive prices from contractors in this market. In addition, arts and cultural organizations and artist-entrepreneurs may be in a good position to work together in order to leverage buying power. They can become market makers for certain buildings or neighborhoods that were in transition prior to economic change.
We can tie this contradictory situation back to the earlier discussion around the new government stimulus package and the importance of making the economic case for arts and culture? This is the time – in a crisis – to build local partnerships between government, philanthropy, and the private sector designed to maximize available opportunities to upgrade arts and cultural space as part of the economic recovery.
For those institutions that can move forward with real estate projects and may even be able to demonstrate savings by entering into the right real estate situation, local partnerships can assist by establishing: 1) property acquisition and development funds; 2) high quality commercial real estate technical assistance; and 3) the use of quality data to estimate both the demand and supply of physical space. And where possible, this assistance should be connected to the broader planning that is now happening in cities around the country around how to re-energize local economies.
As always the missing ingredient is often the right kind of civic leadership that can work the aisles between public, private, and civic sectors – and understands the critical role of arts and culture in 21st century American society. The opportunities will be realized through this kind of entrepreneurial and cross-sector leadership. The real estate deal is just its by-product.