NEW YORK, March 17, 2008 (PRIME NEWSWIRE) -- The recurring waves of news about the housing downturn, job losses, the ongoing credit crunch and general slowing in the U.S. economy have begun to overflow into the commercial real estate sector, according to the 1Q 2008 edition of PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r).
The survey found telltale signs of weakness in office, retail, lodging and leasing activity, while areas less affected by the broad economy, such as industrial and warehouse properties, remain stable. Rental apartments are the only area of commercial real estate benefiting as supply tightens, homeownership rates decline and the number of renters grows.
"Unexpected job losses in January and February -- particularly in the financial industries -- are beginning to have an impact on office space demand in a number of markets," said Tim Conlon, U.S. real estate leader for PricewaterhouseCoopers. "At the same time, widespread cutbacks in consumer spending are causing more pain for the nation's retail sector."
"Even though the underlying fundamentals of commercial real estate are still sound, there are noticeable cracks forming in the foundation," said Susan M. Smith, editor-in-chief of PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r) and manager in PwC's real estate business advisory services group. "As a result, there is a palpable sense of uncertainty among investors we spoke with and surveyed this quarter," she said.
The report reviews comments by analysts forecasting declines in commercial real estate values of 20 percent or more, and questions how much of today's uncertainty is grounded in reality and how much is simply psychological: "Such (analyst) reports capture the attention of newsrooms and quickly filter to the industry. Has the economic prognosis for 2008 infected analysts such that commercial real estate values are really at such risk? Theoretically, it is possible for commercial real estate values to drop to the degree forecasted by these analysts. Practically, it may not be."
"(The) relationship between economics and real estate is not always clear cut. Both are cyclical and need to be looked at jointly, as well as independently, especially during fragile times of economic uncertainty," the report notes.
Other key findings include:
* Despite year-over-year declines in absorption, overall
absorption remains positive for many of the nation's central
business district (CBD) markets, with rental rates holding
steady and even rising in some markets. (For this quarter, the
average initial-year market rent change rate for the CBD office
market held relatively steady at 4.05 percent -- one of the
highest rates ever recorded for this market in the Survey.)
* In the national suburban office market, the pace of leasing has
decelerated noticeably. Even so, developers have forged ahead
with new office projects that continue to increase the level of
supply in many markets. At the same time, the amount of
speculative space has greatly increased, growing from 60.0
percent to 85.0 percent of the total suburban office market.
Suburban office markets posting some of the highest additions to
supply in the fourth quarter of 2007 included Phoenix (4.0
million square feet), Northern Virginia (3.2 million square
feet) and Dallas (2.7 million square feet).
* The subprime mortgage crisis is actually helping to enhance the
national apartment market as woes in the residential market
force more people back into the rental pool, while existing
renters find the idea of homeownership to be cost-prohibitive.
In addition, a continued restraint on new building by apartment
developers is holding down the level of supply.
Additional findings by sector include:
Retail
Declining consumer confidence, a sharp rise in personal bankruptcy filings and a drop-off in consumer spending are taking their toll in the regional mall market. In December, 2007, comparable same-store retail sales posted a 0.10 percent year-over-year decrease, compared to a year-over-year growth rate of 3.8 percent in the prior month and 3.1 percent a year earlier. At the same time, the Consumer Confidence Index fell from 90.6 in December 2007 to 75.0 in February 2008 -- the lowest in 12 months, and well below the 103 average throughout much of 2007.
Lackluster retail sales growth and weaker consumer spending are also causing would-be investors in the national power center market to exercise much more scrutiny and more conservative underwriting, with big-box retailers maintaining a significant role in the sector. According to investors surveyed, overall cap rates (OARs) continue to vary based on a power center's percentage of big-box space, averaging 7.13 percent for properties with 100.0 percent big-box space, compared to 7.27 percent for properties where 85.0 percent of the gross leasable area (GLA) is occupied by big-box tenants and 7.38 percent for properties where 75.0 percent of the GLA is occupied by big-box tenants.
Rising vacancy rates continue to impact community/neighborhood shopping centers -- the result of a slowdown in tenant expansions and constant additions to supply. In the fourth quarter of 2007, approximately 12.0 million square feet were completed in the U.S. community/neighborhood shopping center sector -- the highest quarterly total in three years. Even so, regions with significant population growth report relatively strong results, including West Coast markets such as Orange County, Los Angeles, Seattle, San Francisco and San Diego, as well as certain infill areas such as Suburban Maryland and Northern Virginia. In addition, soaring population growth in Georgia has led to strong demand for retail goods and services, making Atlanta a top pick for institutional investors looking to acquire strip shopping center assets.
Office
In the face of declining absorption levels in many major central business districts (CBDs) during the past several months, the recently released U.S. employment figures showing reconfigured job losses of 22,000 in January and 63,000 in February added a new concern for landlords and investors. Among the hardest hit were office-using employment sectors such as financial services and professional-and-business service entities. Individual CBDs that reported sharp declines in overall absorption in 2007 included Chicago, midtown and downtown Manhattan, Houston and Washington, D.C. In contrast, CBDs that reported strong gains in overall absorption in 2007 included Los Angeles, Atlanta, Bellevue, WA and Baltimore.
In the national suburban office market, leasing activity slowed noticeably thanks to a continuing sluggish economy. Even so, the pace of new construction, much of it speculative space, continued to increase -- leading to growing investor concerns about the long-term effects of oversupply. Suburban office markets posting some of the highest additions to supply in the fourth quarter of 2007 included Phoenix (4.0 million square feet), Northern Virginia (3.2 million square feet) and Dallas (2.7 million square feet).
Industrial
Although individual market performances vary, overall, the national flex/R&D market is seeing a steady increase in demand, thanks to steady growth in the high-tech sector and higher rental rates in comparable office building locations. The tightest markets tend to be located along the West Coast and include long-standing favorites like Silicon Valley, La Jolla and Los Angeles/Orange County. During the past quarter, the average overall cap rate for the national flex/R&D market stood at 7.47 percent, 100 basis points above that for the national warehouse market. Even though investments in flex/R&D can run "hot and cold," the potential for higher returns is quite appealing to investors, the report says.
Warehouse
Favorable supply-demand fundamentals and the sector's minimal sensitivity to changing consumer spending habits or job growth are helping to reinforce the warehouse sector's image as a "safe haven" for many investors. And while the credit crunch did affect would-be buyers' ability to acquire debt toward the end of 2007 (resulting in a 22.0 percent decline in sales of significant properties in the fourth quarter), huge portfolios in the first half of 2007 made it a record year in terms of sales volume. All told, more than $46.0 billion of industrial properties changed hands in 2007, a 7.0 percent increase over 2006. Warehouse markets that attracted the most dollars from investors in 2007 were Los Angles ($2.9 billion), Chicago ($2.2 billion), Seattle ($1.1 billion), Dallas ($1.1 billion), and Atlanta ($1.0 billion). Warehouse markets reporting the highest average prices per square foot included the New York City boroughs ($152.00 per square foot), San Diego ($149.00 per square foot), Los Angeles ($140.00 per square foot) and Orange County ($131.00 per square foot).
Apartments
Growth in the number of renters -- due in part to residential owners, hard-pressed by the subprime mortgage fallout, returning to the market, and also to the inability of existing renters to afford to become homebuyers -- is actually helping to spur demand in the national apartment market. At the same time, apartment developers nationwide have exercised a continued restraint on new building, thereby holding down additions to supply. At year-end 2007, the top five apartment markets in terms of lowest vacancy rates were New York (2.1 percent), Long Island (3.0 percent), Northern New Jersey (3.2 percent), Fairfield County, CT (3.3 percent) and Central New Jersey (3.4 percent). The top five apartment markets for total sales volume in 2007 were Manhattan ($8.0 billion), Washington D.C./Northern Virginia ($3.7 billion), New York City boroughs ($2.0 billion), Chicago ($1.9 billion) and Los Angeles ($1.6 billion).
Net Lease
The old saying that "cash is king" became especially evident in the national net lease market as transaction activity plunged during the fourth quarter of 2007 -- a sharp response to the ongoing credit crisis. Between the third and fourth quarters of 2007 the number of net lease assets sold fell 73.0 percent -- down from 12,266 in the third quarter to a mere 3,290 in the fourth quarter of 2007. The greatest drop in transactions (77.6 percent) occurred in the office sector, where a total of 18,164 net lease assets were available for sale at year-end 2007, down about 25 percent from the third quarter. Retail assets led the offerings (9,558 assets), followed by office (5,082 assets) and industrial (3,528 assets).
National Lodging
The slowdown in the U.S. economy, combined with increasing consumer restraint in discretionary spending are being felt in the U.S. lodging industry, which experienced a slowing in the growth of two key industry averages, average daily rate (ADR) and revenue per available room (RevPAR) in 2007. Even so, industry profits are forecast to rise steadily -- from $28.0 billion in 2007 to $29.6 billion in 2008 and $32.5 billion in 2009.
At the same time, growth in new supply has accelerated over the past two years, with room starts rising from 139,700 in 2006 to 141,500 in 2007. These numbers compare favorably to the construction levels recorded between 2001 and 2005, when new room starts ranged from 68,400 in 2002 to 90,500 in 2001 and averaged 80,220. Even though no immediate threat of an oversupply exists, many investors express concern about the timing of many new projects, although their fears seem to be eased somewhat by the fact that stricter underwriting guidelines from lenders, high land prices, and higher construction costs for material and labor will likely lead to the delay, postponement or cancellation of some projects.
PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r), now in its 21st year of publication, is one of the industry's longest continuously produced quarterly surveys. The current report provides detailed overviews of 29 separate markets, including the national retail markets (regional mall, power center and strip shopping centers); overviews of 18 major office markets, including the recently added markets of Charlotte, Denver, Phoenix and San Diego; and national overviews of the CBD and Suburban Office, Flex/R&D, Warehouse, Apartment, Net Lease and National Lodging Markets. The report also features up-to-date commentaries concerning Valuation Issues, Technology News and Trends and Economic News. New this quarter is a forecast of overall capitalization rates, as well as a breakout of key indicators -- discount rates, overall cap rates, and residual cap rates -- for each surveyed market.
Information about subscribing to PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r) can be found at www.pwcreval.com. Members of the media can obtain an electronic copy of the full report by contacting Thomas Derr at thomas.derr@us.pwc.com or (646) 471-8268.
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