Health Care and Economy and Environment and Real Estate & Retail

BEHIND THE NEWS: Cautious streak helps Duke weather tumultuous times

September 15, 2008

Duke Realty Corp. has stayed largely out of the headlines this year, which in an economy like this is a pretty good sign.

Another Indianapolis developer, Lauth Property Group, has shed more than half its 450-person work force, and Premier Properties Inc.- perhaps the city's most daring developer-lurched into bankruptcy court.

Meanwhile, Duke, which specializes in suburban office and industrial development, keeps on chugging.

To be sure, the company isn't immune to broader economic slowdown. In April, it laid off 45 employees, or 3.3 percent of its 1,200-person work force. Last month, it cut another six positions after deciding to shutter its tiny retail arm.

And Duke has scaled back its pipeline of new projects, in part because demand from tenants has softened and also because turmoil in the financial markets has made capital harder to come by. It expects no more than $1 billion in development starts this year, down from $1.2 billion each of the prior two years.

Yet in the world of real estate development-an industry known for risktaking-Duke has charted a comparatively cautious course.

Unlike some developers, Duke's business model isn't built upon constructing properties, then flipping them for cash. And that's a good thing because the market for selling some types of real estate has all but shut down.

At Duke, Chief Operating Officer Bob Chapman said, "Ninety percent of our earnings come from rent on properties. You are going to see ups and downs, but it is still a more conservative model."

Reducing risk

That's not all the company has done to hedge its bets. These days, it's minimizing its exposure to speculative development and upping its focus on build-to-suit projects and health care construction.

Much of the credit on the health care front goes to Jim Bremner, an early leader in the field.

In 2004, Duke formed a joint venture with his company, locally based Bremner Healthcare Real Estate. Two years later, it bought the business outright.

Health care development is a quintessential relationship business. Duke forges ties with leading hospital systems across the country-such as St. Vincent Health in Indianapolis-then grows along with them.

Demographics suggest it will be a strong segment for a long time.

Health care spending as a percentage of the nation's gross domestic product is expected to increase from 14 percent now to 23 percent by 2020, according to a report by Robert W. Baird & Co. analyst David AuBuchon. By 2030, 70 million Americans will be 65 or older.

Health care properties account for just 3 percent of Duke's assets now, but are expected to reach 12 percent by 2010.

"The significant [and growing] presence of health care within the portfolio should act as an anchor during an extended economic downtown," AuBuchon said in the report.

Investor anxiety

In an environment like this, however, investors are seizing on the negatives, such as the company's lowerthan-expected financial results for recent quarters.

That helps explain why Duke shares are sagging, shrinking the company's stock market value to $3.7 billion. The company's shares now fetch about $25.50 apiece, off 25 percent since October.

But are investors overreacting? Duke's Chapman acknowledges that U.S. developers tend to be overzealous in the good times, when the easy availability of credit triggers overbuilding. But he said the demand for space is far closer to being in step with supply than it was during the 1991 recession, a downturn that decimated the real estate industry.

Supply and demand

In fact, Chapman said, the commercial real estate business remains relatively robust.

He believes the troubles facing his industry are largely financial-not operational. The woes started with trouble in the home-building industry, which mushroomed into the credit crisis.

That helps explain why the company's occupancy is holding up relatively well. In the second quarter, overall occupancy was 87.2 percent, up from 86 percent at the end of the first quarter but down from 88.5 percent a year earlier.

"I don't want to sugarcoat the whole thing. There is definitely some slowness," Chapman said.

"But instead of having three or four or five prospects for space in a particular building, we might have one or two now."
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