Recession Makes Innovatin More Critical to Georgia Manufacturers

The recession has expanded the business advantages of Georgia manufacturers that compete on the basis of innovation in new or technologically improved products, processes, organizational structures or marketing practices. These innovative companies are more than twice as profitable as firms competing on the basis of low price.

That's one conclusion of the 2010 Georgia Manufacturing Survey, which also found that companies are preparing for post-recession growth, expanding export capabilities, addressing sustainability issues -- and still dealing with out-sourcing and in-sourcing. The survey, which included nearly 500 manufacturers, was conducted by Georgia Tech's Enterprise Innovation Institute, the Georgia Tech School of Public Policy, and Kennesaw State University, with support from the Georgia Department of Labor and accounting firm Habif, Arogeti & Wynne, LLP.

Georgia has approximately 10,000 manufacturers that provide nearly 350,000 jobs and account for 11 percent of the gross state product. Workers in manufacturing companies earn wages averaging nearly twice those of workers in retail companies.

The survey found a widening profitability gap between manufacturers that compete on the basis of innovation compared to those that use other competitive strategies. That gap has grown in each survey conducted since 2002.

"Companies that compete on the basis of innovation are much more profitable, pay higher wages and more likely to benefit from in-sourcing opportunities than firms that compete on low price," said Jan Youtie, the survey's director and a principal research associate in Georgia Tech's Enterprise Innovation Institute. "Adoption of an innovation strategy can be useful to manufacturers regardless of industrial segment, and is especially important during difficult economic times."

As part of the survey, companies were asked to rank six competitive strategies for their importance to winning sales. More than half of the respondents mentioned "high quality," while approximately 20 percent chose "low price" or "adapting to customer needs." Fewer than 10 percent reported "innovation/new technology" as a primary competitive strategy.

Across all six strategies, innovation was associated with the highest mean return on sales: 14 percent, compared to just six percent for the low-price strategy. And those financial benefits extended to workers, whose annual salaries averaged $10,000 per year more at innovative manufacturers than at other companies.

The top five innovative tactics reported by respondents were (1) working with customers to create or design a product, process or other innovation, (2) signing a confidentiality agreement to access a new product or process, (3) working with suppliers to create or design a product, process or other innovation, (4) purchasing new equipment, and (5) conducting research and development activities in-house.

While manufacturers of technology products are most often associated with the strategy, innovative companies can be found in all industrial segments, said Philip Shapira, co-director of the survey and professor in the Georgia Tech School of Public Policy.

"Many people think that innovation is something that has to be done in a lab, but our results show that innovation occurs more broadly, particularly as companies partner with customers and suppliers to take into account their needs for a new product or process," he explained. "While high technology companies tend to be innovative by their nature, innovation occurs across all segments, and every firm has opportunities to be innovative."

Companies often cite cost as a reason for not innovating, but Shapira noted that only 10 percent of companies take advantage of R&D tax credits; fewer still use investment tax credits. "While financial incentives can assist innovation, there is a greater need to build awareness and capabilities among more of the state's firms to undertake innovation," he said.

Though more than two-thirds of Georgia's manufacturers have cut jobs or lost sales in the recession, many of these companies are now looking toward the future with plans for locating new customers, boosting capital investment, expanding research and development and continuing to reduce costs.

"When we look at their plans, Georgia manufacturers are in an expansive mood, looking for new customers and getting ready for the next phase of economic growth," Youtie said.

The survey found that 70 percent of respondents were looking for new customers, 20 percent planned to expand capital investment, and 15 percent planned to increase expenditures on research and development. At the same time, 60 percent of respondents said they still planned to cut costs.

Another trend studied was growth in the number companies selling to international markets. More than half of the responding manufacturers said they were exporters -- and those manufacturers reported 50 percent higher profitability than non-exporters. Some 22 percent of respondents had increased their export sales since the last survey in 2008.

"We don't find much difference between exporting companies when comparing them by the amount they export," Youtie noted. "What seems to be important is the capability to export. We think there is some learning that takes place, and some capability that a company develops to become an exporter. That capability translates into improved performance across the board, in addition to creating new markets and different margins."

The survey also found that out-sourcing of work has leveled off, with approximately 16 percent of manufacturers affected by the loss of business in 2010. At the same time, the percentage of firms benefitting from in-sourcing -- movement of work to Georgia -- has grown to nearly 15 percent.

"Out-sourcing isn't going away, but it has stabilized," Youtie said. "In-sourcing appears to be growing, which creates opportunities for good manufacturers to benefit from consolidation of production from other U.S. facilities or even from overseas."

The study also looked at sustainability issues, and found that 60 percent of companies recycle and attempt to reduce waste -- one form of sustainability. However, just 11 percent of respondents had inventoried their carbon footprints or emissions, and fewer than five percent were using renewable energy.

The bottom line for manufacturers?

"The results of our survey can point manufacturers to a way forward for getting ready for the next phase," said Youtie. "Companies can develop innovation capabilities; they can look into exporting and they can collaborate more with suppliers and customers."

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Recession's Effects Intensify in Cities

/PRNewswire/ -- Cities' finances continue to weaken under the strain of the recession, resulting in cities being less able to meet their fiscal needs in 2011 and beyond. According to the National League of Cities' annual report on cities' fiscal conditions, financial officers report the largest spending cuts and loss of revenue in the 25-year history of the survey.

In the research brief, "City Fiscal Conditions in 2010" (http://nlc.staging.10floor.com/ASSETS/AE26793318A645C795C9CD11DAB3B39B/RB_CityFiscalConditions2010.pdf), 87% of city finance officers report their cities are worse off financially than in 2009. City revenues - as generated in property, sales, and income taxes - will decline -3.2% in inflation-adjusted dollars according to finance officers. To compensate, city officials are cutting back spending, with expenditures declining by -2.3%. These are the largest cutbacks in spending in the history of the survey and the fourth year in a row that revenue declined.

Financial pressures are forcing cities to layoff workers (79%), delay or cancel capital infrastructure projects (69%), and modify health benefits (34%). There were also significant increases in the number of officers reporting across-the-board services cuts (25%) and public safety cuts (25%). Public safety is usually reduced only as a last resort option.

"This historic recession has forced city officials to make difficult decisions that impact the social and economic fabric of their communities," said Ronald O. Loveridge, mayor of Riverside, CA and president of NLC. He continued, "This recession is making city officials fundamentally rethink and repurpose the provision of services in their communities. Some are innovating and finding creative solutions but, regrettably, without the necessary resources, cities will continue to have a difficult time assisting their residents through these trying economic times."

The ongoing weakness in the housing market, along with poor retail sales, has reduced the available revenue by significant margins. The responses from the finance officers clearly illustrate that the effects of the economic crash are intensifying in cities. Because most tax revenue is collected at specific points during the year, and since it takes time for housing assessments to catch up to current values, cities will still be feeling the full effect of the downturn in 2011. The national economy's slow recovery to date also means the recession's effects will potentially linger in cities for several more years.

"These stark numbers continue the trend we've been seeing for the past several years: lower revenue and reduced services at a time when there is an increased demand for services," said co-author Christopher Hoene, director of the Center for Research and Innovation for the National League of Cities. He continued, "Unfortunately, because of the loss in revenue, cities will face even more difficult circumstances in the months, if not years, to come."

Cities have been forced to confront low consumer spending, unemployment, and cuts in state aid that have severely affected the types of services and the manner in which they are offered by cities. In response, many cities are revisiting the range of services provided and looking for new service-delivery models in order to balance budgets and minimize the impacts of cuts on residents.

"While certain segments of the economy may be under recovery, cities as a whole are not yet experiencing growth," said co-author Michael A. Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago. He continued, "As a consequence, cities are facing very serious financial hurdles right now in providing basic public services."

NLC conducts the survey each year in partnership with the University of Illinois at Chicago's College of Urban Planning and Public Affairs, a nationally recognized innovator in education, research, and engagement in support of the nation's cities and metropolitan areas. Michael A. Pagano, Dean of the College, has helped conduct the survey and author the report since 1991.

The National League of Cities is the nation's oldest and largest organization devoted to strengthening and promoting cities as centers of opportunity, leadership and governance. NLC is a resource and advocate for 19,000 cities, towns and villages, representing more than 218 million Americans.

Through its Center for Research and Innovation, NLC develops, conducts and reports research on issues affecting cities and towns. The Center assists cities and their leaders to implement innovative practices by providing qualified information and technical assistance.

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Six Tips for Business Leaders to Consider as We Emerge from Recession

(BUSINESS WIRE)--Now that we are finally seeing some signs that we may be beginning to come out of the long recession, what should we be doing to fully take advantage of a recovery? That’s the question most middle market executives are asking today.

Rich D’Amaro, Chairman and CEO of Atlanta-based Tatum LLC, the nation’s largest executive service firm focused primarily on the Office of the CFO, has developed a list of six tips which should serve as a basic guide for financial executives in the coming months.

1. Identify and Maintain Your Strengths, and Your Best Customers

Identify the strengths that have enabled your success to date, and those that will be important in the future. Which capabilities and skills are most critical? What distinguishes your ability to serve customers effectively? Identify your highest-margin customers, and understand what you are “doing right” for them. Develop a game plan to protect and build on the strengths that have allowed you to be indispensable to these customers. Rather than cutting costs across the board, think about how you can shift resources to retain these high-margin customers, and attract more customers like them.

2. Capture Market Share: Consider Opportunistic Acquisitions

Recessions reshape industries faster than good times do, creating opportunities for those with the vision and ability to seize them quickly. Studies have shown that companies have twice the opportunity to change their relative position in an industry during a recession compared to growth times. Keep an eye on competitors, and stand ready to capture market share as other players allow cost cutting to damage their service and quality, or fail outright. Market valuations are still down for strong and weak companies alike, and companies with resources to acquire complementary rivals will earn higher returns than they can with internal, organic growth. Of course, acquire only companies that support your ability to be the best in the world at what you do, and work aggressively to capture synergies. New opportunities may also exist to gain new alliance partners, to move into adjacent markets, to adopt new pricing models, or to enter new channels. Some of these opportunities may be created by the failure of competitors, and some may be created by a new customer appetite for solutions that show measurable ROI or reduce risk.

3. Manage Liquidity As Closely As Profitability

Your company has been dealing not only with negative growth but also with liquidity constraints. During good times you may not have obtained sufficient lines of credit to sustain your company through economic adversity. Trying to maintain liquidity on a smaller revenue base can be crippling. Every balance sheet dollar has to be turned over faster to contribute to working capital. Maximize cash flow by matching inventories to sales and collecting from customers faster. Take advantage of increased supplier willingness to share risk and to provide favorable terms.

4. Keep Core Activities In-House, and Outsource Everything Else

Build and protect those “core” capabilities that differentiate you, while aggressively outsourcing anything non-core. Depending on your business, non-core activities may include IT maintenance, human resources administration, benefits and payroll, accounts receivable and payable, manufacturing, distribution or sales. You’ll get the benefit of service provider expertise and economies of scale, and will pay only for services you need. The biggest benefit of outsourcing, however, is that it shifts your focus, resources and capital toward serving your clients’ higher value needs and building your competitive advantage.

5. Create New Metrics and Manage by Them

Tight economics put a premium on your ability to understand and model the relationships between revenues, costs and margins. Think about metrics that focus on the building blocks of revenue and sustaining market share, including sales pipeline, customer satisfaction, pricing and market penetration. Metrics should look beyond core financials to provide management with insight into market dynamics such as market share trends. The good news is that the enhanced metrics you need during challenging times will help you manage more profitably and efficiently in good times as well.

6. Communicate and Reenergize!

A downturn is a scary time for all your constituencies. You now need to begin the process of re-energizing your employees and creating new trust among all your constituencies. Frequent and honest communication will go a long way toward maintaining a calm and motivated workforce. Create regularly scheduled forums to listen to concerns, and to update employees on the state of the company and on their roles in achieving new company objectives. Studies show that employees are motivated far more by a sense of shared purpose than by compensation. Create that shared purpose and reinforce it daily. Lead your company out of the recession with realistic confidence, candor and a renewed sense of direction.

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Can Companies Maintain Quality as They Cut Costs?

This week, U.S. Federal Reserve Chairman Ben Bernanke announced that the "recession is very likely over." While there are indicators to suggest the American economy is in recovery, executives at most companies are still grappling with ways to manage costs.

Indeed cutting jobs continues to be a leading method companies use to prop up their bottom line. In August, economic concerns prompted businesses to shed a net 216,000 jobs, driving the national unemployment rate up to 9.7% last month, according to the latest U.S. Department of Labor report.

But is cutting human capital always the best option? Faculty at Emory University and its Goizueta Business School say indiscriminate cuts can yield unintended consequences over the long term, and add that trimming away expenses instead of hacking at them may be a better strategy.

“The steps that companies should be taking during this recession are different from what they usually actually do,” warns Al Hartgraves, a professor of accounting at Goizueta. “Often, they reduce spending in training, maintenance, advertising and other discretionary cost areas just because it’s easier to cut in these areas. That may help profitability in the short term but it may hurt in the long term. Another common solution is an egalitarian approach where each department is required to cut its budget by a fixed percentage.”

But a better alternative is a “zero-based” approach, a sort of clean-slate strategy where each department has to justify and prioritize every component of its budget, he says.

“The advantage is that a zero-based approach adds transparency to the process and may help to highlight the essential costs and benefits of different functions,” Hartgraves explains. “Zero-based budgeting can help management to zero in on strategies that might have made sense during the boom times but are now dragging down earnings.”

Another important issue involves analyzing fixed costs to current revenues, he notes.

“During the boom years when companies expected to continue their growth curve, many firms increased their manufacturing, storage, distribution and other capacity,” Hartgraves says. “But in a downturn, the underutilized assets may have an outsized negative effect on the bottom line. [To counter this,] it may be a good time to dispose of machinery and equipment, buildings and other fixed assets that are older or less productive, thereby lowering their break-even point. When the economy rebounds, those assets can be replaced with newer, more productive assets.”

For decades, companies in trouble have first turned to downsizing, reducing human capital and operations in terms of the number of products and services offered, notes Shawn Davis, a visiting assistant professor of accounting at Goizueta. “However, in times of recession companies should proceed with caution,” she says. “To begin with, businesses should engage in activity-based costing and management: effectively evaluating their core operations and core projected operations to identify and eliminate non-value-added activities and costs.”

Non-value-added activities are operations that are either unnecessary or inefficient, Davis explains. “As such, they’re dispensable and their removal will not affect the quality, performance, and perceived value of the company’s main products and services.”

Externally, a firm also should conduct customer-profitability analysis to determine the activities, costs and profit associated with individual customers, according to Davis. “Companies are likely to make better decisions about customer service if they have a good understanding of which customers are generating the greatest profit,” Davis explains. “Cost-cutting strategies that result in the loss of a profitable customer would weaken, not improve, the company's position. As such, this profitability analysis would better help companies determine where to devote its limited resources in serving customers.”

Davis also says it’s not uncommon for companies to take an axe to research and development efforts in tough times. But they should proceed with caution, she adds.

“R&D tends to be a primary target when cutting costs is underway because these efforts generally do not provide immediate returns,” she says. “The key here is for companies to instead review their R&D efforts and weed out the ones that have the least long-term potential.”

Firms are better served if they forge ahead with efforts that offer a high pay-off expectation, she adds.

“Moreover, statistics indicate that companies that spend more on innovation during a downturn fair much better and get a higher return on capital in a recovery compared to ones that use a downturn as an excuse to scrimp on R&D.”

Quick-thinking firms may even find opportunities in a recession, according to Charles F. Goetz, an adjunct professor of organization and management and a distinguished lecturer in entrepreneurship at Goizueta.

“During a tough economy, many companies scale back their activity,” Goetz notes. “But a business that can invest in its operations may be able to expand its market share.”

Meanwhile, he says, all companies should be looking for ways to cut waste from their operations.

“You have to cut costs in a way that’s appropriate for your individual circumstances,” Goetz cautions. “Let’s say you’ve got a service-based business that rarely brings clients back to its home base. In that case, you may be able to jettison some office space—saving the outlay of lease costs—and perhaps have your people work from home.”

Healthcare and travel costs also represent cash drains that may be addressed and reduced.

“Outsourcing your employees, through professional employer organizations (PEO), may save money,” Goetz says. “Besides taking care of administrative tasks, PEOs may be able to group together large numbers of small business workers under a single PEO umbrella and offer more leverage when it comes to negotiating healthcare coverage.”

Businesses also should reconsider their inventory order processes and such mundane matters as travel policies, he says.

”If your company maintains inventories of items, can you reduce your stock of goods?” Goetz asks. “Consider analyzing your inventory levels to see if you can maintain a leaner volume of goods, and see if you can negotiate with your suppliers for discounts, longer payment periods, or both. Additionally, try to convert fixed costs to variable costs that more closely track your sales by taking such steps as outsourcing more processes and leasing your equipment instead of buying it.”

If a business’s owners decide they need to cut salaries to survive, it is important to consider the psychological impact as well as the financial impact, Goetz notes.

“Make sure that top management is also taking a cut in salary, and it may be a good idea for the owners to take an even larger percentage cut,” he says. “Let the employees know that management is sharing the pain; otherwise you’ll have disgruntled employees who may hesitate to put much effort unto their jobs.”

One of the simplest and least painful ways to cut costs involves eliminating unnecessary product lines, or SKUs [stock keeping units], according to Jagdish Sheth, a chaired professor of marketing at Goizueta. The problem is that many companies focus on the wrong attributes when they pursue this strategy, he says.

“When companies reexamine their SKUs, they frequently focus on the cost of production, but ignore vital issues like logistics and storage costs,” he explains. “They also need to execute a thorough profitability analysis to determine if they’re carrying too many lines of products.”

As an example, Sheth cites consumer products companies that may produce multiple varieties of toothpaste and shampoos, manufacturers that make a wide range of appliances that serve similar functions with minimal differentiating characteristics, or flavor and fragrance firms that make a wide variety of flavors and fragrances that are essentially variations on a few central themes.

“Along with too many SKUs, companies with multiple product lines tend to lose sight of their individual products’ profit margins,” he cautions. “The aggregate business may be profitable, but a close examination may reveal that certain product lines are operating at a loss and are being subsidized by other, successful ones.”

“In a slow economy, it may not be advisable to keep carrying the laggards,” he counsels. “This may be the time to jettison the unprofitable lines unless there are compelling reasons to keep carrying them.”

The challenge has been compounded by the trend of “bundling,” or offering a variety of services (or occasionally goods) at a discounted price. One example is automobile companies that offer option packages, or suites of add-on configurations, like a larger engine, a specific transmission and perhaps an upgraded sound system. Another example is cable companies that offer bundled telephone, Internet and television packages that cost less than the total of the individual services purchased separately.

“For a long time, bundling was seen as a positive move since it enabled a company to get more of a customer’s business,” Sheth says. “The disadvantage is that it can mask cross-subsidies that may actually eat into a business’s profit.”

Firms should review their customers to determine if too many resources are being devoted to clients that are minimally profitable, Sheth adds.

“Some of the larger food production companies will service their bigger customers directly from company-controlled distribution centers,” he says. “But their smaller or less profitable accounts could be outsourced to third-party logistics companies that can still turn a profit with the smaller client companies.”

In some cases, it simply may not be worthwhile to keep a customer, Sheth adds.

“An effective analysis will utilize activity-based costing to allocate all of the related costs, including transportation and other overhead, by each customer,” he explains.

“Companies often overlook costs like vendor management and support activities including accounting, finance and procurement that are tied to specific customers but are not accounted for. Even worse, some of these overhead support systems may be unique to the customer, instead of being performed as part of a centralized department that can at least deliver economies of scale,” he says.

Analyzed like this, it is not unusual for some companies to find that 80 percent of their profits are generated by 20 percent of their customers, adds Sheth.

“If you discover this is the case, then some tough decisions may have to be made,” he says. “We’re already seeing this in some service firms, like accountants and lawyers who set up new offices or expand existing ones to make it easier to service a key account, only to shut down the new locations after discovering that the marginal growth did not yield the anticipated profits.”

At a time when the economy is spurring companies to reduce costs, executives must remember to balance expense reduction and quality, Sheth warns.

“Keep in mind that good service tends to increase revenue, so don’t compromise on quality,” he said. “On the other hand, bureaucracy and other inefficiencies hurt your bottom line. So be sure to keep your priorities in order as you seek to improve your operations.”


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Tips for Small Businesses to Avoid Cash Reserves in a Recession

/PRNewswire/ -- As if the recession is not enough to deal with, for small and medium businesses that are growing during these hard times you need to be aware that your credit card processor may view your growth as a potential indicator that you are at risk of going under and institute cash reserves. Unfortunately the industry has learned from experience that some merchants, about to go under, commit fraud by processing bogus orders to bolster cash flow; which is seen by the processor as a spike in sales from the merchant. In a time where bankruptcies and business closures are rising it is only natural that processors are nervous.

An unfortunate byproduct of this negative behavior is that legitimate merchants showing too much growth over a short timeframe can also be branded as being at "risk." For those of you that may not understand the way the relationship between merchants and processors works, the processor is on the hook to pay for any consumer losses, chargebacks, if a merchant goes out of business and cannot, or decides not to, cover those losses.

This being said, it should be understood that a spike in sales is not the only reason a processor may want to implement reserves, there are a number of factors that are looked at. The point is if you are one of the lucky few merchants experiencing growth you can take proactive steps that could help you avoid the reserves scenario.

First: Open Communications -- Talk with your processor, tell them about your growth, show them recent press releases or financials that show your growth is in fact healthy. Make sure to talk about why you are experiencing growth in a down market. Did you reduce your prices? Do you have the market cornered? New hot product releases? Did you get better pricing on your goods?

Second: Set Expectations -- Let them know if you are going to be having any type of large promotion, sales event or hot new product release. No one likes to be surprised, and you don't want the processor to sound the alarm when they see your sales skyrocketing from sales of the next Tickle-Me Elmo craze they didn't even know you were selling.

Third: Customer Service Signals -- I can't say this with enough emphasis, you need to manage your customer service signals, chargebacks, credits and refunds. If you successfully open a dialogue and set expectations but your customer service signals don't support the story you are telling; you are going to have a tough road to travel.

Fourth: Create a Competitive Situation -- If you are experiencing significant growth, consider connecting to a second credit card processor and running a small portion of your transactions through the second account. This will reduce load on the first processor, making growth look smaller, and it provides you leverage to pressure your credit card processors to reconsider cash reserves.

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Grubb & Ellis Predicts a Challenging 2009 for Commercial Real Estate as Economy Weathers Recession

/PRNewswire-FirstCall/ -- Grubb & Ellis Company (NYSE:GBE) , a leading real estate services and investment firm, today released its 2009 Global Real Estate Forecast, which indicates that 2009 will be a challenging year for commercial real estate with the economy starting the year 13 months into what may become the longest recession since the 1930s.

"The economy will struggle in 2009, which will dampen demand for all product types, resulting in negative absorption and increased vacancy," said Robert Bach, senior vice president, chief economist of Grubb & Ellis. "We expect total payroll job losses in the range of 1 to 2 million in 2009 on top of the 2+ million in 2008. GDP is likely to shrink by 1 percent in 2009, compared with growth of 1.3 percent and 2 percent in 2008 and 2007, respectively."

The investment market, which saw transaction volume plummet in 2008 as the financial markets collapsed and the credit markets froze, is expected to see a 15 percent increase in sales volume in 2009 as distressed properties are brought to market, particularly those acquired in the past couple of years with floating rate debt. Loan delinquencies and foreclosures will increase with more properties returning to lenders, who will be anxious to sell them. Debt capital will remain expensive and tight in 2009, but more of it will be available than in 2008, and there will be a slow increase in equity capital flowing into the market from private, institutional and offshore investors waiting on the sidelines. The coming year should be more active as the gap between buyers and sellers gradually narrows, with sellers making up most of that difference.

Debt will be the hot investment type in 2009. Investments could be made in CMBS, collateralized debt obligations or funds investing in these assets. Or debt investments could be made at the property level with owners seeking to refinance their properties. More equity investments will be made as well in 2009 as investors holding an estimated $300 to $400 billion in institutional, private and offshore equity begin to deploy their capital in response to falling prices.

The outlook is equally challenging for global markets, both developed and emerging. The previous contention that emerging markets would largely escape the financial crises in North America and Europe looks to be overly optimistic. This will not be an ordinary downturn, but rather a structural correction in global capital markets that will impact every sector of the economy and real estate market.

One benefit of the global market correction has been the rapid evaporation of inflationary pressures in most key economies. The decline in inflation has left governments less reticent in using interest rates as a weapon in the battle to stave off sharp economic and commercial decline.

Office Tenants Will Have the Upper Hand in 2009

The office construction pipeline contained 90 million square feet at year-end 2008, the lion's share of which will be delivered in 2009. This combined with a projected 45 million square feet of negative absorption, including a big jump in sublease space, will push vacancy up by two percentage points to end 2009 at 16.5 percent. Tenants will have greater negotiating leverage in 2009 with concession packages becoming more generous as the year progresses. The growing inventory of sublease space will put downward pressure on asking rental rates for direct lease space, which are expected to decline in the range of 4 to 5 percent for both Class A and B space by year-end.

"Employment growth drives demand for office space and the labor market will be shrinking in 2009," said Bach. "Government and health care will be among the few sectors with growing demand for office space."

In this difficult market, Washington, D.C. should be at the top of office investors' buy list, according to Grubb & Ellis' Investment Opportunity Monitor, a proprietary market ranking in which Grubb & Ellis annually measures 60 office, 53 retail, 56 apartment and 55 industrial markets against 13 to 17 criteria important to the performance of real estate investments. Washington, D.C., is the one market that will benefit from the credit crisis as the government expands to implement its economic recovery plan.

Following Washington, D.C., on the top 10 list are Portland, Ore.; Los Angeles; San Francisco; Austin, Texas; Dallas-Fort Worth; Houston; Raleigh-Durham, N.C.; Boston; and Oakland, Calif. The Texas markets offer strong population growth, while the others offer strong population growth as well as natural barriers to entry.

Industrial Users Strive to Reduce Costs

Businesses look at industrial space as a productivity enhancer, an integral part of their supply chain strategies. Their relentless quest for cost-saving efficiencies should sustain demand for industrial space in 2009, despite the weak economy. However, supply is expected to outpace demand with absorption dipping into the red and the vacancy rate rising by 60 basis points to end the year at 9.4 percent as the construction pipeline delivers space still underway.

"The industrial market will recover more quickly than the office market because the construction pipeline is set to thin out sooner," said Bach.

For the third consecutive year, the logistics business is driving demand for space in Grubb & Ellis' Investment Opportunity Monitor's 2009 rankings. Los Angeles retained the top spot on the list, with its proximity to the busiest ports in the U.S., negligible vacant space and little developable land. Also making the list were other cities with nearby port facilities including Houston (No. 2), Oakland, Calif., and Seattle (tied for No. 4), Miami (No. 8), Portland, Ore. (No. 9) and New Jersey (No. 10). Inland distributions hubs Atlanta (No. 3), Dallas (No. 6) and Chicago (No. 7) rounded out the list.

Will Consumer Spending Rebound in 2009?

Consumer spending hit a 28-year low in 2008 with retailers in the crosshairs of the downturn. Grocery store-anchored centers in mature trade areas will hold their ground in 2009, while centers on the urban fringe, where housing construction has stalled will suffer. Retailers will be even more conservative with their expansion plans in 2009, with more store closings and fewer openings. Expect higher vacancies and softer rental rates by year-end.

"Value retailers are garnering the majority of consumers' dollars in this challenging economic climate," said Bach. "Even the luxury retailers, which are usually immune to downturns, are feeling the pain."

According to Grubb & Ellis' Investment Opportunity Monitor, no retail market will escape the effects of the recession entirely, but some offer more protection due to factors such as strong population growth, a high median income and/or limited land for further development. Los Angeles topped the list for retail investment followed by Washington, D.C. California had an additional three cities in the top 10 with Orange County (No. 6), San Francisco (No. 7) and San Diego (No. 9). Texas appeared three times with Houston (No. 3), Dallas (No. 4) and Austin, Texas (No. 8). Also making the list were Atlanta (No. 5) and Portland, Ore. (No. 10).

Multi Housing Will See Vacancy Rising as Well

The housing slump and recession have produced countervailing forces that will both help and hurt the multifamily market in 2009. Apartments are seeing some new renters who have lost their homes to foreclosure, while landlords are able to maintain existing renters who are waiting for prices and mortgage rates to fall further. However, new graduates who can't find jobs are doubling up with a roommate or moving in with a relative to conserve cash. At the same time, the apartment market faces competition from an increasing supply of unsold condos and foreclosed homes returning to the market as rentals. The negative forces are expected to have a slight edge in 2009 resulting in slowly rising vacancies for the multi housing market this year.

Of the top 10 apartment markets in Grubb & Ellis' Investment Opportunity Monitor, seven are on the West Coast and three are on the East Coast. All offer barriers to entry, good economic prospects and high home prices. Los Angeles ranks first followed by San Francisco; Orange County and Oakland, Calif.; Washington D.C.; San Diego; New York City; San Jose, Calif.; Long Island, N.Y.; and Portland, Ore.

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PKF Forecasts 7.8 Percent RevPAR Decline in 2009

/PRNewswire/ -- U.S. hotels have entered the initial stages of one of the deepest and longest recessions in the history of the domestic lodging industry. The 7.8 percent drop in RevPAR that PKF Hospitality Research (PKF-HR) is now forecasting for 2009 will be the fifth largest annual decline in this important measure since 1930. Further, PKF-HR is forecasting that the nation's hotels will not experience a year-over-year quarterly increase in RevPAR until the second quarter of 2010. The projected seven consecutive quarters of declining RevPAR, beginning with the just reported third-quarter decline of 1.1 percent, according to data from Smith Travel Research (STR), marks the longest stretch of falling revenues endured by U.S. hotels since STR began tracking performance data in the late 1980s.

PKF-HR recently updated its forecast based on STR lodging performance data through September of 2008 and the November release of Moody's Economy.com economic forecast for the nation. The forecast results are presented in the fourth quarter 2008 edition of Hotel Horizons(SM), a quarterly series of reports containing five-year forecasts of performance for the U.S. lodging industry and 50 major markets across the country.

Mark Woodworth, president of PKF-HR, noted that, "the speed and severity of the downturns in employment and income continue to accelerate. Given the strong correlation between these two economic measures and demand for lodging accommodations, we are forecasting 2.5 percent fewer occupied rooms in 2009. This follows an estimated 1.0 percent decline in demand for year-end 2008."

The expected 2.5 percent fall off in demand, combined with a 2.9 percent increase in supply, will result in a 2009 year-end occupancy level of 57.6 percent. This represents a 5.3 percent decline in occupancy, and is 5.1 percentage points below the long-term average occupancy level for U.S. hotels tracked by STR of 62.7 percent. "The combination of above average net increases of supply occurring simultaneously with dramatic declines in demand is something we have not seen in recent industry recessions. This is what makes this downturn so severe," Woodworth said.

Discounting Impacts Profits

Through the first three quarters of 2008, U.S. hoteliers were holding the line against discounting despite declining levels of demand. In fact, room rates were up 3.7 percent through the first nine months of the year, a pace greater than the long-term average for ADR growth. "The severity of four consecutive down quarters of occupancy was too much for hotel operators to bear," Woodworth observed. "Starting in October 2008, we began to observe year-over-year declines in ADR. Given the expected deterioration of market conditions, we are forecasting a 2.7 percent decline in rates for 2009. This is just shy of the combined 2.9 percent decline in ADR suffered during the two-year period 2001 and 2002."

The ability to drive revenue by increasing room rates creates the most profitable environment for hotels. Therefore, the 2.7 percent fall in room rates leads to the projection of a 14.0 percent decline in net operating income (NOI) for the average U.S. hotel from 2008 to 2009. NOI is defined as income before deductions for capital reserves, rent, interest, income taxes, depreciation, and amortization.

"Looking back at previous industry recessions, we know that hotel managers will respond and cut costs," Woodworth said. "Fewer occupied rooms will reduce variable expenses such as payroll and operating supplies. In addition, management will eliminate some fixed overhead costs and non-essential guest services and amenities. Recent declines in energy prices will help this cost reduction effort." PKF-HR is forecasting unit-level operating expenses to decline by 4.5 percent in 2009, but this falls short of the 7.3 percent loss in revenue.

Fortunately for U.S. hotel owners and lenders, the vast majority of properties are fiscally fit entering the current downturn. Unit-level profit margins are estimated to be 29.4 percent in 2008, well above the 26.1 percent long-term average. Interest coverage ratios for the hotels in PKF-HR's Trends in the Hotel Industry exceed 1.7. While PKF-HR does not believe the current forecast will generate abundant hotel foreclosures and bankruptcies, operating conditions are at vulnerable levels and further deterioration could impact the solvency of U.S. hotels. "In view of the significant volatility in the domestic and global economy, a negative bias on this outlook is appropriate," noted Jack Corgel, the Robert C. Baker Professor of Real Estate at the School of Hotel Administration at Cornell University and senior advisor to PKF-HR.

Most Markets Will Suffer

"In keeping with our long-standing view that the lodging industry is a street corner business, we focused heavily on the outlook for the major hotel markets in the nation," Woodworth said. "We have developed 100 unique econometric forecasting models that project the performance of both the upper- and lower-tier properties in 50 of the largest cities in the country."

Except for New Orleans, all of the 50 markets analyzed by PKF-HR are forecast to suffer a decline in RevPAR in 2009. The main culprit for the decline in RevPAR is the forecast fall-off in demand. In 40 of the 50 markets, PKF-HR is forecasting a lower number of rooms to be occupied in 2009 as compared to 2008. In 18 of these markets, an above average increase in the supply of hotel rooms exacerbates the competitiveness of the marketplace.

"When analyzing the declines in RevPAR forecast for the nation's major markets, it certainly appears that warm-weather, leisure-oriented, and seasonal markets are most vulnerable in 2009," Woodworth observed. Five of the top seven forecast city declines in RevPAR are expected to occur within the State of Florida. The other two markets in the top seven are Phoenix and Oahu. "Further reductions in airline capacity amplify the negative operating environment in these markets brought on by weak economic conditions." Previous research by PKF-HR found that a 1.0 percent increase/decrease in airline capacity yields a 0.39 percent increase/decrease in lodging demand at the national level.

Beyond 2009

Come 2010, the relevant economic indicators are forecast to begin to drive lodging demand upward. This will happen simultaneously with diminished levels of new supply, thus resulting in gains in occupancy and, eventually, pricing power. "Given all the lodging industry will have to deal with in 2009, it is hard to look beyond a 12-month window. However, a glance at 2010 does reveal the beginning of an upward trend," Woodworth concluded.

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