Investment Basics
Investor Survey: Commercial investors remain confident
By Florida Association of Realtors®

Investor survey: Commercial investors remain confident
NEW YORK -- July 18, 2006 -- Investors remain confident about commercial real estate, according to the latest quarterly report from PricewaterhouseCoopers. That optimism comes despite concerns about higher energy costs, rising interest rates and the possibility of higher capitalization rates down the road, notes PricewaterhouseCoopers' Second Quarter 2006 Korpacz Real Estate Investor Survey.

"With the overall economy showing continued strong gains in employment as well as high levels of consumer confidence, investors seem poised to continue their long-standing infatuation with the U.S. commercial property markets," says William Croteau, U.S. real estate sector leader for PricewaterhouseCoopers.

The quarterly survey of professionals involved with the real estate industry -- including institutional investors, REITs, pension funds, mortgage bankers, developers and insurance companies -- identifies trends across key real estate industry sectors. Other notable findings include:

• All-cash buyers, such as pension funds, are replacing leveraged buyers by aggressively pursuing investment opportunities in many individual markets, thanks in part to increases in interest rates.

• After a record number of condo conversions in 2005, the first three months of 2006 saw only 14,000 units converted -- the lowest level since mid-2004.

• The retail industry as a whole continues to perform well and attract investors' interest, though a number of national retailers have announced plans to close stores or scale back on planned openings.

Additional findings, by sector, include:

Office markets

Within the national Central Business District (CBD) office market, investors continue to focus attention on new acquisitions of individual properties as well as complete portfolios.

Though recent increases in interest rates are putting the brakes on the purchasing ability of some leveraged buyers, many all-cash buyers, such as pension funds, are picking up the slack and aggressively pursuing investment opportunities in many individual markets. In fact, overall transaction activity of significant CBD office properties was up 10 percent in the first quarter of 2006, compared to the same period in 2005. Manhattan, Chicago, Los Angeles and Phoenix headed the list of most active U.S. office markets over the past year.

In the national suburban office market, steady employment gains and limited new supply are helping to lower vacancy rates across the board while leading to increased rental rates in many individual areas. In the first quarter of 2006, the overall weighted average rental rate for the national suburban office market stood at $22.71, a full 4.50 percent increase over the $21.73 level recorded during the same period in 2005.

Thanks to steady demand and rising rental rates, landlords in many areas have begun scaling back on concessions and incentives used to lure tenants when the markets were softer. As vacancy rates continue to fall, many investors are also looking forward to the potential for rental increases if this positive trend continues.

Industrial markets

The national warehouse market continues to perform well with many individual geographic markets reporting strong demand, decreasing vacancy rates and rising rental rates. With so many warehouse markets performing well, investment demand as been voracious, with a record $10.5 billion of significant industrial assets traded during the first quarter of 2006.

Industrial assets in the western part of the country continue to attract the lion's share of investor interest. In Los Angeles, for example, a total of 190 industrial assets changed hands in the 12 months leading up to April 2006. Other very active markets along the West Coast included Seattle, Orange County and San Jose. On the East Coast, industrial sales activity has been particularly robust in and around large metropolitan areas such as Boston, where 71 industrial properties were bought and sold in the 12 months leading up to April 2006, and suburban Maryland, where 151 industrial properties were traded during the same time frame.

Flex/R&D markets

Like their office and warehouse counterparts, many individual flex/R&D markets across the country have seen declines in vacancy in recent months thanks to improved tenant demand and a lack of new construction. In Los Angeles County, for example, the overall vacancy rate for flex/R&D space fell to 5.4 percent in the first quarter of 2006. And while vacancy rates for flex/R&D space are significantly higher in many other local markets, they have been trending downward as well. For example, in Denver the overall vacancy rate for flex/R&D space declined to 16.3 percent at year-end 2005, while in Charlotte, it dipped to 19.2 percent in the first quarter of 2006.

Retail markets

The retail industry as a whole continues to perform well and attract investors' interest, despite a number of national retailers announcing plans to close stores or scale back on planned openings. The national regional mall market saw a total of 100 malls sold across the country during the 12 months leading up to May 2006. And while the volume of retail properties offered for sale remains heavy, total sales volume has slowed recently, with only 12 regional malls trading hands during the first quarter of 2006. One reason for the drop-off is that investors are finding fewer quality assets available for sale, according to the survey. In addition, investors are seeing overall capitalization rates begin to stabilize, with a likely upward trend in the offing.

In the national power center market, the performance of individual big-box and discount retailers varied from location to location. Even so, many continued to outperform traditional merchants in terms of year-to-year retail sales growth. As a result, investor interest remains very strong for well-located power centers that offer a diverse tenant mix and high barriers to entry. While some investors expressed concern about the possibility of rising overall cap rates, most were optimistic that this would be offset by increases in net operating income. National power center investors also recognize a "bigger is better" factor, according to the survey, as they expressed a distinct preference for big-box versus "mom-and-pop" sized stores which are seen as carrying more risk and higher levels of overall capitalization rates (OAR).

The national strip shopping center market continues to attract interest from many investors, but total sales volume in this sector fell by as much as 12 percent between the first quarter of 2005 and the first quarter of 2006. One reason for this decline, especially among grocery-anchored centers, is increased competition for big-box merchants and bulk warehouse retailers -- a situation that is further reflected by a continuing spate of grocery store closing, bankruptcies and consolidations across many geographic markets.

At the same time, many investors report that available assets are priced at premium levels, even though overall capitalization rates appear to have stabilized or begun to rise. The apparent gap in bidding versus asking price will likely be further exacerbated by growing competition from new centers. Shopping center industry analysts expect available space to increase by 377 million feet in 2006, resulting in a 20-basis-point rise in the national vacancy rate by the end of the year.

Net lease markets

Transaction volume in each net lease segment -- sale-leaseback, 1031 exchange, and triple-net-leased properties -- remained at vigorous levels during the first quarter of 2006.

The sheer volume of net lease transactions has resulted in a tighter variance between OARs for investment grade and sub-investment grade tenants. As a result, investors are placing greater emphasis on the underlying fundamentals of the real estate in a net lease transaction. Given the shrinking gap between short-term and long-term interest rates, transaction activity may be further stimulated in the sale-leaseback sector as corporations seek alternate methods of raising capital.

In fact, sale leasebacks have emerged as a popular long-term capital source for convenience store ("c-store") operators, the survey finds. While the c-store sector historically has been dominated by REITs, an increasing number of institutions, including private 1031 investors, are considering c- store acquisitions due to their higher yields in the competitive retail investment market. Generally, c-stores backed by corporate credit are more appealing than those with franchise credit. Thus, in lieu of corporate credit, the valuation of the underlying real estate is critical. One drawback to c- store investments as a long-term player in the net lease market is their dependence on fuel sale revenues since pricing pressures exist from other retailers.

Apartment markets

The winter months saw a jump in interest rates, a drop-off in concessions, sluggish apartment absorption and a general slowdown in condo conversions. Fort Lauderdale, Los Angeles and Orange County each reported the lowest apartment vacancy rates nationwide.

After a record number of condo conversions in 2005, the first three months of 2006 saw only 14,000 units converted -- the lowest level since mid-2004. Part of the reason may be related to rising interest rates. While rising interest rates typical strengthen the multifamily market, the return of some condos to rental units may have a short-term negative effect on apartment market fundamentals. This effect may be especially evident in markets such as South Florida, where a large number of investors entered the condo market with the intent of capitalizing on a housing trend.

At the same time, rising interest rates and overall capitalization rates are reducing margins in many apartment transactions, thereby pricing many leveraged buyers out of the market. As a result, the slowdown in condo conversions remains in evidence, dropping to 15 percent of all sales during the first quarter of 2006. By comparison, condo conversions accounted for approximately 25 percent of total apartment sales in 2005.

By geographic market, Broward County and Orlando continue to see significant activity, but sales have slowed significantly in Tampa, Naples/Sarasota, Phoenix and Las Vegas, when compared to 2005.

© 2006 FLORIDA ASSOCIATION OF REALTORS®



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