As the downturn bites the latest Emerging Trends survey shows increased interest in apartments and industrials as well as a move up the popularity stakes for Denver, Houston and Boston. Robert Ruggles and Chuck DiRocco report
"Forget the quick fix" is the opening quote from an investor, and the overall feeling for the commercial real estate market, found in the 30th edition of Emerging Trends in Real Estate released in October at the Urban Land Institute's (ULI) fall conference.
According to the 2009 publication forecasts, the real estate market will have a rough year and suffer setbacks due to the many issues that continue to affect the economy.Emerging Trends is produced jointly by PricewaterhouseCoopers and the ULI. It covers 50 markets across the US, four cities in Canada, and has just introduced a new chapter looking at real estate markets across Latin America.
The survey is based on detailed face-to-face interviews with over 270 of the industry's leading authorities conducted by PricewaterhouseCoopers partners and directors, as well as ULI researchers. This, combined with more than 440 survey responses, gives a consensus view of over 700 real estate professionals. The survey is known for its city and property sector projections, along with insights into real estate capital markets and the economy in general.
In 2008 the US credit crisis continues to be the largest contributing factor for economic decline and remains a problem that is yet to be resolved. This problem has damaged the credit markets, and what remains is just a fragment of what once was. This failure was due to financing deals that offered individuals opportunities that were realistically outside their repayment capacities.
Due to a large number of bad deals, the US housing market continues to decline in value while the government remains focused on financial assistance through a variety of methods to individual homeowners to maintain home ownership.
Consumer spending continues to decline when you combine mortgage repayments with increased energy prices, inflation, a weakening stock market and world turmoil. As one interviewee stated: "People simply don't have the dollars to spend."
With all of these problems, the US economy continues to lose strength and dip into a recession; therefore, pushing the commercial real estate industry into a period that will be marked with losses in property values, a decline in revenue, and an increase in commercial foreclosures and delinquencies.
Additionally, vacancy rates will increase and rents will soften as companies attempt to stay afloat by cutting costs and jobs, therefore needing less space in which to operate. As a result, owners will focus on maintaining tenants and securing rent flows. "Do whatever it takes to get tenants to stay," agrees one owner. In spite of ownership focus, the survey respondents agree that private equity real estate investments will suffer negative total returns in 2009, something the industry has not experienced in nearly two decades.
These expectations of negative returns are observable in the survey's ‘markets to watch' section where respondents rank investment and development city prospects on a scale of one (abysmal) to nine (excellent). Comparing 2009 and 2008, investment prospects shows an average value decline of just over 13%, with only Houston and Dallas increasing, based mostly on a boost in energy-related businesses. Regardless of a decline in investment, capital is looking for less risk and has interest in quality properties, global pathways and 24-hour cities. As one investor stated: "The major markets provide shelter," and "long-term returns".
In this year's survey investor interest results seem similar to 2008. Seattle is ranked first again, and seven cities remain in the top 10 in 2009. Perennial leaders San Francisco, Washington, DC, and New York took the second, third and fourth spots, respectively. Moving into the top 10 investment cities are Houston, Boston and Denver, with the northern Virginia market, Orange County and Honolulu dropping out. Las Vegas, Phoenix, Sacramento and Miami suffer a significant drop in interest as, according to respondents, these cities have been the hardest hit due to the housing market, combined with an overdevelopment without any current demand.
Even though the draw to city real estate investments dropped, values did not fall as much as development rankings in 2009. Average development numbers fell over 34%, with all cities being less than the previous year. Respondents expect developers will face a dismal year due to the lack of finance for new constructions and the difficulty of leasing completed projects.
Fortunately, development activity in commercial real estate markets has remained at a controlled pace through the stronger years, maintaining good supply/demand equilibrium. Similar to investment prospects, seven cities remained in the top 10 compared with 2008. Seattle also topped the list of development prospects followed by Washington, DC, and New York. If developing, the focus should be on mixed use, infill areas and mass transportation systems, says the survey. With a decline in the economy, people want to be closer to services and have shorter commutes.
Declines were found for both investments and developments throughout all of the major property sectors, except apartment construction, which has increased since last year. This increase in apartment rentals can be attributed to the young adult demographic as well as the unfortunate decline in the housing markets.
Following the apartment sector is an interest in the industrial market where investors are looking to obtain a steady cash flow. Unfortunately these efforts might fall short as consumer confidence and spending slows, meaning a possibility for lower inventories and less shipping activity. Survey participants also believed that CBD offices in stronger markets will experience less decline than suburban offices that have dropped off their radar.
In 2009 commercial real estate investments and developments are expected to face a tough year according to the survey. Similar to what the wider general economy faces, there does not seem to be one specific action to address the problems ahead for this industry.
Real estate owners will have to return to basics and focus on property management and operations in an attempt to keep leases stable. Such a strategy for properties that are not highly leveraged and in prime global markets should be a key factor in surviving the current economic storm.
Chuck DiRocco is director and Robert Ruggles is partner at PricewaterhouseCoopers