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Editor's note: This is the 10th installment in's Home Front series, a collection of twice-weekly features examining how American business, society and investing have changed in the post-Sept. 11 landscape.

Before Sept. 11, concerns about the slowing economy's impact on real estate were beginning to weigh on the minds of real estate investors.

Now, such worries seem trivial since the destruction of the World Trade Center has changed the face of commercial real estate forever. Yet even today, nobody is certain of the future of the sector.

If the economy was on the brink prior to Sept. 11, the explosions in New York and Washington pushed it over. Yet decisions driven not by economics but by safety, strategy and convenience will also profoundly affect the commercial property markets.

For investors interested in real estate holdings, understanding the potential changes and their implications will be key to profiting from bricks and mortar in the coming months.

Lagging Behind

There is little doubt of the detrimental impact of the Sept. 11 attacks on the U.S. economy. "While the U.S. economy was already showing signs of weakening, the impact of the Sept. 11 attacks has clearly accelerated and intensified the slowdown of the national economy," Wachovia Securities director of real estate research Christopher Haley recently told clients.

And as the weak earnings of real estate companies in the third quarter showed, real estate investment trust, or REIT, fundamentals will probably get worse before they get better.

"While the economy started weakening earlier in 2001, we saw the more pronounced effects of real estate companies' reported earnings the third quarter as occupancy rates are decreasing and rents are moderating," Haley said. "We also believe it is fair to say that the impact of the slowdown since Sept. 11 is probably not fully reflected in the weaker earnings results seen thus far due to the lag. We would expect the next several quarters, perhaps more, to remain quite difficult with regards to weakening real estate fundamentals."

Indeed, real estate is typically a lagging indicator: Fundamental trends in real estate tend to follow the general economy rather than serve as a predictor of future economic activity.

Though REIT earnings were slightly better than third-quarter expectations, the prevailing trend is not a friend of REIT investors. "The ratio of positive to negative earnings surprises was approximately 2 to 1, which is down substantially from the year-ago period when the figure was running closer to 4 to 1," said Steve Sakwa, director of real estate research at Merrill Lynch.

Not all regions of the country are equally affected during a recession, and the same is true for real estate markets. Haley expects to see significant weakness in the real estate markets in both the Midwest and the Northeast, and he believes that the Southern California market will suffer the least.

If that holds true, companies with a focus on the Southern California market --


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in the apartment space -- could outperform peers with property concentration in weaker regions.

From a sector perspective, recessions historically hit office real estate the hardest. For example, in the 1990-91 recession, office companies were the first to post negative returns and the last to recover from the slowdown. Conversely, multi-family real estate was the least affected.

New Paradigms

While an economic slowdown will have a pronounced influence on commercial real estate, changes in corporate strategy in the wake of Sept. 11 will also affect how and where REITs and other real estate developers focus their futures.

Even Donald Trump, the trophy real estate icon, says he doesn't believe he will build 100-story towers again, a clear suggestion that real estate paradigms are shifting.

However, though real estate pundits initially predicted a mass exodus from Manhattan into the suburbs of New Jersey and beyond, the anti-Manhattan battle cry hasn't reached the fervent level many expected.


brokers expect the northern New Jersey market to experience migration of corporations from Manhattan longer term," Haley notes. "However, the level of migration since Sept. 11 has been less than many had anticipated."

Part of the problem was the underestimation of "shadow space" in Manhattan: vacant real estate leased by corporations that don't actively search for a sub-lease. Much of that space housed tenants displaced by the September terror.

How much space was available in Manhattan? According to one broker, over four million more square feet of additional office space was on the market in Manhattan on Sept. 30 than on Sept. 11.

Though the mass exodus hasn't happened as some predicted, Manhattan may continue to see a slow, steady drain on demand as corporations disperse employees to avoid the impact that disasters can have on a concentrated workforce. A number of commercial real estate brokers in Manhattan continue to report contact with corporate clients developing longer-term plans to decentralize their operations.

In suburban New York markets, REITs that could benefit include


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In addition, corporations may look far beyond the Hudson in an attempt to further diversify. "The ripples from this 'rock in the puddle' will help suburban NYC and maybe disperse some of Wall Street's labor into other major cities throughout America," said Carl Tash, principal at Cliffwood Partners, a Los Angeles real estate investment management firm, shortly after the World Trade Center attacks.

One thing is clear: The ripples from Sept. 11 are causing a reconstruction of commercial real estate paradigms in Manhattan and beyond.