2008 CPN Goldbook - (Page 4) INDUSTRY UPDATE A Different Year Slower Economy Likely to Impact Commercial Real Estate—Amount TBD By Suzann D. Silverman A popular reflection upon the past 12 months is, “What a difference a year makes.” Indeed, after several years’ run-up in pricing, the capital markets finally stalled out in the second half of last year in response to the singlefamily residential meltdown and resultant marketwide credit crunch. While plenty of prognostications regarding future performance of various parts of the real estate business have arisen, they are generally tinctured by concerns about a possible recession—with mixed views on its likelihood. For instance, Grubb & Ellis Co. senior vice president & chief economist Robert Bach gave the occurrence a 40 to 50 percent probability in his 2008 Real Estate Forecast, while a paper by Torto Wheaton Research, a CB Richard Ellis Inc. company, cautioned in January that talk of a recession is premature and stated that the economy is actually undergoing “a slowmotion slowdown.” Last year marked a record for property sales, the culmination of about five years of continuous, 40 to 60 percent year-over-year increases in activity, according to Real Capital Analytics Inc. president Robert White Jr. But last year’s monumental pace owed largely to a significant amount of portfolio sales and privatizations, while the one-off market declined across most property types, White noted during a presentation at the Mortgage Bankers Association’s February Commercial Real Estate Finance/ Multi-family Housing Convention & Expo. The Blackstone Group L.P.’s $39 billion purchase of Equity Office Properties Trust in February 2007 and the subsequent sales of a number of spun-off portfolios certainly were big contributors; together, the deals came to $66 billion, according to Real Capital Analytics. Prices are generally expected to correct by about 10 to 15 percent, White noted, and cap rates, which finally shifted into reverse in September, had already risen 100 to 150 basis points by February, with a reduction in Treasuries preventing a bigger increase. Steady leasing buoyed the heady sales market in the first half of 2007, according to Grubb & Ellis, with office vacancies continuing to decrease and rental rates to rise. Office vacancies leveled off in the second half, finishing the year at 13 percent, while the industrial sector remained stable as new supply was added and retail, despite an active leasing market, continued to see the rising vacancy rates that had also marked the second half of 2006 (although they remained below 8 percent). Both the multi-family and hospitality markets performed well, the former reflecting a return to renting in When Will Prices Fall? (national property performance, prices per square foot*) 10% 5% 0% -5% 3-month % change 12-month % change -10% -15% -20% 4Q 2007 Price PSF Apartment Apartment Office CBD Garden Mid-/High-Rise Office Suburban Retail Warehouse $102 $211 $120 $225 $189 $115 *based on properties and portfolios of $5 million and greater Source: Real Capital Analytics Inc. Will Vacancies Flatten—or Spike? (U.S. vacancy rates*) 20% B 15% 10% 5% 0% B B H J F J H F J H F J H F B B B B J H F B J H F B 13.2% J 7.8% H F 7.6% J H F J H F 5.9% 2000 B Office 2002 H Retail 2004 2006 2008-F* J Industrial F Apartment *assumes slow or no growth: recession would cause vacancy-rate spike Sources: Reis Inc. & Grubb & Ellis Co. Room to Grow—but How Much? (amount delinquent by property type, $ in millions) $1200 $1000 $800 Jun-2007 $600 $400 $200 $0 Lodging Retail Healthcare Multi-Family Office Nov-2007 Dec-2006 Mar-2007 Sep-2007 Oct-2007 Source: Standard & Poor’s response to the weak single-family housing market and the latter the result of strong corporate performance. The extent to which second-half-2007 trends will continue into 2008 depends on a number of factors. Employment growth, already flat to negative by yearend 2007, according to Mortgage Bankers Association senior vice president & chief economist for research and business development Douglas Duncan, is expected to drop this year, which may impact the commercial real estate sector. In addition, energy prices remain high and the dollar weak. Predictions are for commercial delinquencies to rise further. And a number of commercial real estate companies, owing to high debt levels relating to acquisitions, face questions about their futures. On the other hand, a late 2007 report by Principal Real Estate Investors, Real Estate Research Corp. and Torto Wheaton noted that corporations are expected to continue spending, as is the government in this election year. The report further pointed to the fact that a weak dollar makes for stronger exports and that unemployment levels are so low that they have room to increase without significant negative impact. Other positives more directly impact the commercial real estate industry. The weak dollar is attracting foreign investors, and a number of other types of investors also remain active, according to White. Delinquency levels have room to increase without great impact (for more on the finance market’s performance, see “Proceed with Caution” on page 42). Furthermore, while the office market is expected to absorb half the level it absorbed in 2007, according to Grubb & Ellis, that will likely increase the vacancy rate by only 20 basis points, which could permit a slight rental rate rise. The multi-family and industrial sectors are also likely to remain stable, although retail and hospitality face national economy-related challenges. 4 Commercial Property News Price PSF 2008 Goldbook
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