Ben Johnson: First and foremost, there is a lot of attention on Devon Energy’s new corporate tower. Is that the most important dynamic happening now with OKC’s office market? Or is there something else?

 

Mark Beffort: Obviously Devon is the story for downtown and will be for the next five years. But if you want to talk about possible change, Chesapeake Energy has probably been the best corporate citizen that we’ve had over the last five years. And they’ve had a dramatic impact on the real estate market and the suburban market, not just in the 63^rd Street and Western area (where the company recently completed a new headquarters campus) but outside that.

 

The thing that scares me the most is natural gas prices. If the current pricing of $3.60-3.80 [per million btu] continues, which I believe it will, over the next six to nine months, there is going to be a lot of change and I’m not sure it will be for the better.

 

From a positive standpoint, we still have activity but not as much as we’ve had. I don’t see rental rates decreasing significantly unless we have a large unforeseen happening. Occupancies will continue to hover where they are for the next two to three years. I also don’t think we’ll see a lot of new construction in office.

 

Ford Price: The one thing I might add as relates to the oil and gas sector is president Obama's proposed budget where he’s proposing to get rid of intangible drilling cost and depletion allowance for independents. I’ve talked to my friends in the oil and gas business and they’re pretty scared about it. They don’t think all of it is going to go through but they are real nervous that some of it could go through and negatively impact on the economics of drilling.

 

I don’t think it’s an overstatement to say that the Obama administration is pretty hostile to the oil and gas industry at this point, and if it goes through as written, that’s a bad day for the oil and gas business and therefore for Oklahoma City and for our office market.

 

Bob Sullivan: In the office market there is a lot of sublease space out there and I’m not sure it is all being reported. As those leases roll over and that all comes onto the market, we could see a significant increase in vacancies over the next 12 months. I really do see a softening in the market. People want to make commitments for the shortest time possible for the least amount of space as possible. It’s all that unknown that we’re seeing out there, all of the new policies and new regulations.

 

Tim Strange: There is the sublease and there is the shadow sublease. We’ve been approached by several tenants saying ‘Help us renegotiate our lease, and go to the landlord and see if they will cut back our space or length of our term.’ Landlords are taking a very hard line as far as I can tell now. So that’s forcing some of these companies to make really hard decisions. Do they gut it out at a rent they probably can’t afford to pay or do they try to sublease some of their space. In some cases they are sitting on a third or half more space than they need today. I don’t think we’ve seen that play out yet. Have many of your tenants approached you?

 

Michael Laird: Do you think the landlords can hold that position for an extended period?

 

Sullivan: As soon as the leases expire then all of this space comes on the market, but until that happens they [landlords] have no reason to take a softer line.

 

Chuck Wiggin: How big do you think this sublease overhang is? I’m not sure the numbers are big.

 

Sullivan: We have a lot of sublease space available that I’m just not sure is being reported.

 

Beffort: Michael, we take a very proactive approach and if we have an ability to rework a tenant’s lease we’ll do it. Part of the problem we have is all of our properties have long-term capital commitments and you can’t terminate a lease without approval. What you do is try to find somebody to back fill the space. The owners don’t care a bout the TI requirements, they care about the revenue stream. They look at it as their asset and they want to maintain that cashflow. They are much more intent today on looking at the financials than they ever have been.

 

We do see little things with tenant movements where some tenants are downsizing while we are finding others to move into that space. So that makes me optimistic.

 

Strange: So you’re not losing ground, you’re gaining slightly or at least staying even.

 

Wiggin: We’re seeing almost every lease rollover that we’re working on involves some kind of rent bump. We can talk about he possibility of rents softening, but I’m not seeing it. As long as occupancy holds up we may get through this without a whole lot of damage.

 

Beffort: I concur with you. So many of our rents were structured in the $13 to $16 range and as they roll over the market is not bad enough to lower it. I am seeing some shorter terms, maybe from seven or 10 years to one, three or five year deals, but we’re not seeing any decline in rents.

 

Price: This time around you’ve got owners that are much better capitalized. You just don’t have the leverage you did the last time around. I don’t see mass foreclosures or anything approaching what we went through before.

 

Wiggin: There will be selective problems but I agree with you on the whole. Most buildings are well capitalized and the level of debt is pretty modest. I think we are going to see situations where a lot of capital is required for TIs to keep tenants and that’s got to come from someplace and that’s a trick right now.

 

Beffort: The question is will it come from the landlord or the tenant. We’ve had some success with tenants paying that by keeping the rent where it is.

 

Price: That’s a function of the quality of the asset.

 

Beffort: Probably. If you get a little bit better asset and a better quality tenant you can do that.

 

Bryan Geiger: I think another big issue in the multitenant market is the oversupply of garden office buildings, the single tenant and build-to-suit. We’re seeing a lot of those request and specifically people moving out of the CBD to build their own building. There’s an oversupply of that product. At BOK we’ve stopped financing those projects. They are mainly residential developers that have excess land and the next logical step is to put up six or seven garden office buildings.

 

Beffort: The resale on those isn’t very good because they don’t hold their value. And there are a lot of those on the market right now.

 

Strange: You asked earlier about the Devon story, and I’d like to hear how we’re going to fill that space [when Devon vacates its existing space]. My take is we’re going to need a couple of big bluebirds and then some. Where are those bluebirds going to come from?

 

Wiggin: None of us has an answer to that but it is kind of interesting that we’re all stressing out about a building that’s still three years away.

 

Strange: Are we stressing?

 

Wiggin: People are sure talking about it. You’ve heard tenants say this market is going to be oversupplied so they want a deal, they ought to get a rent break.

 

Beffort: I had one attorney who leases 1600 sq. ft. and he only wanted a two-year deal. Why? Because he knows for a fact that Devon is going to place about 200,000 to 300,000 sq. ft. of their own building on the market. So he’s waiting to do a good deal in the new Devon Tower. I hear stuff like that all the time.

 

Price: Tim, you’re right, it is the story. The short answer is nobody knows what’s going to happen and it’s going to be what it’s going to be. And landlords are going to have to deal with it.

 

Beffort: Devon is vacating 800,000 to 900,000 sq. ft. of space, three times as much as we’ve absorbed before, but I firmly believe that we’ll get through this. But, if the oil and gas industry does see a big hiccup, then all bets are off.

 

Johnson: Michael, when Devon moves out of your building, you will finally have some expansion space, right?

 

Laird: Our situation is pretty unique. We’re the only other occupant in that building [Devon’s current headquarters, the Oklahoma Tower] with the top four floors. We’ll be able to expand when they move, but it will be a long time line. In the interim we’re going to have to come up with short-term solutions probably starting 18 months or two years from now when we’re going to be out of space. We’ll be talking to them in the next year or so, but right now we’re fine where we are. I’d accept a great deal, however. (laughter)

 

Strange: Now you’re looking at a rent bump, pal.

Johnson: Are you worried about them moving out?

 

Laird: Not really. Maybe I should be but I’m not. They could sell that building tomorrow if the right investor came in. They could also sell it well after they move out. We’re comfortable that we’re going to be the anchor tenant in a quality building in downtown Oklahoma City.

 

Johnson: How much will the mounting national economic condition impact this market? How much longer can the city shield itself from outside influences?

 

Strange: I think we can. If our activity in our [investment sale] pipeline is any indication then we can keep going for a while. There has been a pickup in LOI activity and hopefully in closings. Most of that is in our normal business. A little bit is in distressed or troubled but not much yet. We’re still seeing a lot investor interest in OKC from out of town. I thought it would go back to a local investor market but that’s not what we’re seeing.

 

Beffort: What do you see on yields?

 

Strange: They’ve definitely gone up.

 

Beffort: How much? By half?

 

Strange: Probably 150 basis points. We’re seeing a reversion back to a 10 cap range for average deals.

 

Johnson: William, we talked about the level of apartment property sales. To what do you attribute the decline?

 

William Forrest: The volume is about the same as it was last year. We were so used to a ridiculous pace. In a normal year we have 30 sales of over 50 units in size, and this year we’ll probably have something in the 20s. It’s not fallen off a cliff as far as the activity level goes but it’s harder to get to the finish line on deals.

 

Johnson: Is the buyer or seller pool changing?

 

Forrest: In the seller pool, we are working on quite a few lender-owned properties, but only a few have actually finished foreclosure yet and most of them are C properties. There isn’t enough trouble in the A or B market for those to trade.

 

Johnson: Can national buyers find distressed apartment deals here?

 

Forrest: They come here because they understand that our market is in a much more stable situation. But everybody still wants to find a high cap rate deal, a distressed asset or a value-add play. Those are just hard to find. They buyer pool has always been private capital for the most part because the few institutional buyers haven’t stayed for any time.

 

Johnson: Why haven’t the institutions come here?

 

Forrest: We just haven’t been on their radar screen as far as the demographics for long-term growth. That may change, but the quality of the asset is still B and C at this point. It’s hard to get enough density and enough units to make them want to be here too.

 

Price: Wouldn’t you agree that if there is a bit of carnage in the local market it’s in that C class product?

 

Forrest: Yes, that’s the only place you’re seeing any trouble. Those deals were just structured badly and would never work no matter what state of the economy.

 

Johnson: Is that the lender community’s fault?

 

Geiger: Not Bank of Oklahoma’s I can tell you that! (laughter)

 

Johnson: John, the hotel market is still meeting challenges in the national economy. What’s your take on the local market?

 

John Williams: It’s a little bit soft right now. Travel is down and people are very aggressive on pricing and trying to drive the cost per stay and cost per night down. They’re looking for great value adds. In our world, the convention activity is off a bit and the attendance at the convention activity is also off. Instead of a company sending 10 delegates to a convention they’re going to send one or two. So it opens up more rooms for occupancy at a somewhat lower rate structure.

 

In our market, we’ve basically almost doubled the amount of rooms downtown in the last three or four years. The Colcord was first, then the Residence Inn about two or three weeks before us, then there is a Hampton Inn in Bricktown, there’s an Embassy Suites in the pipeline over at OUHSC with over 200 rooms, and there has been a lot of talk about other limited service lodging product downtown.

 

Limited service for downtown Oklahoma Cith is not a good thing to have. If we fill the market with limited service rooms we’re not going to be able to draw the right convention activity which typically wants to be housed in one or two hotels. They don’t want to scatter around to 20 limited lodging properties. There has to be some care and real thought in terms of what gets built downtown.

 

Out in the suburbs, on Meridian and on Memorial, I have no idea how those guys are going to succeed.

 

Everybody is looking for a better deal. Last week Starwood, which owns Sheraton, announced a 50% price reduction. I haven’t seen that rate here yet, but if they cut their rate by 50% there will be a problem.

 

Johnson: There is talk of a new convention center and hotel being built south of downtown. How much in this room is the Core to Shore development a challenge and an opportunity?

 

Wiggin: If Devon is three years out, Core to Shore is 10 years out. It’s a way for the community to look forward and imagine the future but it’s not a future that we’re going to see any time soon. That’s a bit of a challenge. We don’t have a long history of looking way down the road. How to interpret that in our current context is where it’s a little bit difficult.

 

I think what’s going to happen is the city is going to propose a new Central Park as part of MAPS3, and if we build this park it’s going to be sitting there all by itself for a long time. Somehow we’ll have to make that work.

 

Beffort: It’s something we can look forward to, and I think it’s going to happen. I love the city’s vision to make the CBD the hub of the city. Eventually we will have rail here, but in what form or fashion I don’t know. I’m very optimistic for the future for the CBD but it’s going to take awhile.

 

If MAPS 3 passes, which I fully expect it to, we will have the capital to see things keep rolling for the next three to five years.

 

The city has hired me to acquire all of the land for Core to Shore. We meet once a month and we have a very slow process in going about it. We’re not swooping in and buying all the land. We’ll be buying it over time. When the Core to Shore project first started to come about, a lot of people swooped in there and started speculating and those people have probably lost some money. Some people are asking $40 and $50 per sq. ft. for land and the city is just not going to pay that. We’re very upfront that we want to buy the land, but the city is not going to overpay.

 

We’re under contract on three pieces right now and we will buy three or four pieces a year and it is going to take awhile. I think it will take us three to four years just to buy the land for the Central Park.

 

Sullivan: The city is talking about a new convention center just west of the Ford Center south of the current I-40, with a 650-room hotel. I think they’re thinking in the right direction, that if we’re going to grow over the next few years or 20 years they’ve got to implement that to attract bigger and stronger conventions.

 

Beffort: That’s got to happen. It’s critical for the city to grow.

 

Williams: I don’t know that the site is cast in concrete. There are a number of different options. A 650-room hotel is probably too big initially. It probably needs to be about 400 rooms and it’s going to be very difficult to finance it. The hotel business out there in today’s world is not great around the country, so I think it’s going to be a tricky thing to finance.

 

But you have to keep in mind that when you build a convention center it doesn’t fill from day one. There is a long ramp-up period because a national or regional convention won’t book the facility until they see it. The whole thing has to be effectively master planned.

 

Johnson: Bryan, if hotels aren’t getting financed now, what is?

 

Geiger: It depends on who you’re dealing with, but I would say office, industrial and multifamily is getting financed right now, with at least 20% equity. We’re looking at doing longer term deals on cash flowing stabilized properties. No new construction. That’s just a general rule now.

 

Beffort: That’s refreshing to hear.

 

Price: That’s a large part of why Oklahoma City is not in trouble. We’ve had a pretty disciplined lending community in this town for many years that requires real equity with good sponsors and people who know what they’re doing.

 

Laird: They really didn’t drink the Kool-Aid here like they did everywhere else.