Commercial Real Estate On the Mend?
Commercial real estate markets continue their gradual, uneven recovery — with investment capital beginning to flow beyond "gateway" and multifamily markets — yet industry executives remain wary about the future amid lackluster job creation; uncertainty over monetary, fiscal and terrorism insurance policy; and rising interest rates, which could lead to deceleration in the pace of property value gains, The Real Estate Roundtable's Q3 Sentiment Survey showed today.There is no doubt U.S. commercial real estate is recovering nicely. The latest report from Moody's Investor Service confirms that fundamentals continue to improve:
The latest survey continues the basically flat trajectory of the past several quarters, with the "Current Conditions" index remaining at 71, the "Overall" index rising 1 point since the previous quarter (to 70), and the "Future Conditions" index rising 1 point (from the 67 points registered in the past two quarters). Although today's figures certainly are in positive territory (being above 50), they also illustrate an erosion of confidence among industry participants as the recovery has dragged on. The Future Index, for example, hit almost 80 in Q2-2010 but slipped below the Current Index around the time of the 2011 debt ceiling crisis (falling to 75), and now stands at only 68, several points below the Current Conditions reading.
"Today's survey indicates a commercial real estate sector and national economy stuck on a plateau of recovery — certainly improved since the worst days of the recession, but not moving forward in any robust way," said Roundtable President and CEO Jeffrey DeBoer. "The slow pace of macroeconomic recovery is directly tied to the 'flatlining' of expectations in our industry, which is why The Roundtable continues to press for an array of federal policies aimed at unleashing investment and job creation," he added.
These include proposals to spur foreign equity investment in U.S. real estate and infrastructure — cited by President Obama in his economic speech this week and reintroduced Wednesday by Reps. Kevin Brady (R-TX) and Joseph Crowley (D-NY). The Roundtable also strongly supports legislation to encourage energy retrofits of commercial buildings; pro-growth tax reform that preserves real estate's role as an economic driver; and balanced immigration reform. [See July 23 real estate letter to U.S. Senators on tax reform] Keeping the U.S. terrorism risk insurance program ("TRIA") in place beyond 2014 is also critical to protecting future credit availability for commercial real estate, and borrowers' ability to refinance maturing debt.
At a meeting of U.S. Senators and industry representatives yesterday, DeBoer underscored the vast policy uncertainty that continues to undermine job creation. "The level of uncertainty today continues to be high. Interest rates, health care, tax policy — all are huge question marks for businesses looking to create jobs and expand," he said.
On the positive side, a majority of respondents in the Q3 survey continued to view real estate market conditions as having improved at least somewhat over the past year (77% in the current survey, compared to 75% in Q2), and there was a slight uptick (from 62% to 65%) in the number of participants anticipating at least "somewhat better" conditions within the next 12 months.
Q3 survey participants also noted increased planning and construction in asset classes outside the multifamily (apartment) segment — as well as increased investor interest outside "red hot" cities such as New York, San Francisco, Dallas and Houston. At the same time, there was a strong undercurrent of caution in the respondents' anecdotal comments. Thus, while prospects are improving in second-tier cities — particularly for "the best assets" and for value-added deals — the bifurcation that has characterized the industry's recovery over the past four years largely continues.
As one respondent said, "Capital is moving up the risk curve in the most popular markets and migrating to the best assets in second tier cities, but for the majority of assets the outlook remains uncertain at best." Echoing these nuanced views of market conditions, another commenter said, "General conditions are good but not terrific. People are still incredibly cautious with their growth plans; everyone is planning on growth, but they are hesitant to take a leap of faith in this economy." Yet another said the "torturous recovery . . . is continuing."
On the subject of interest rates, the current survey revealed a similar split in views between current and future conditions. For now, strong capital availability and optimism about better growth have helped to maintain or even improve property values. Looking ahead, however, numerous respondents in the Q3 survey expressed concern about interest rates and their potential to slow the recovery of asset values, which fell as much as 50% in some markets during the Great Recession (wiping out owner equity and leaving many properties "underwater").
Although the Fed is expected to maintain its highly accommodative monetary policy for the foreseeable future — signaling this week that "tapering" of the "QE3" program is now less imminent — the risk is that interest rates could begin to rise before property owners' net operating incomes (NOI) have caught up with increasing job creation. Artificially low interest rates are also contributing to artificially high asset prices in some areas, so that a sudden increase in interest rates could wreak havoc with property values and pricing.
The Roundtable's Sentiment Index is the industry's most comprehensive measure of leading real estate executives' confidence in financial and real estate markets. The survey, conducted by FPL Advisory Group, captures the perspectives of senior real estate executives, including CEOs, presidents, board members, and other executives from a broad set of industry sectors including owners and asset managers, financial services firms and operators. A PDF of the entire survey report is available online at www.rer.org.
All of the commercial real estate sectors performed strongly in second-quarter 2013 and will continue to do so, according to the latest "Q2 2013: US CMBS and CRE CDO Surveillance Review" from Moody's Investors Service.You can read many reports on U.S. commercial real estate but I like watching what top funds are doing. Carolyn Cummings of the Canberra Times reports, Blackstone bets big on US housing market recovery:
"Despite some muted economic indicators, commercial real estate property markets benefitted from a limited amount of construction, as well as positive absorption," said Michael Gerdes, Managing Director and head of Moody's US CMBS & CRE CDO Surveillance. "With favorable fundamentals, transaction volumes remained healthy."
"As in the previous quarter, multifamily and hotel markets continue to perform strongly, although the pace of improvement is going to slow down. The recovery of the office and retail sectors has been more muted but their performance will also improve, in tandem with employment and economic growth."
"Our central economic scenario remains the same; our Macroeconomic Board Outlook forecast is for US GDP growth of about 2% this year because of fiscal policy and public spending cuts. With housing starts and employment still growing and consumer sentiment improving, we expect US growth of 2.0%-3.0% and a decline in the unemployment rate to 6.5%-7.5% in 2014," added Gerdes.
Moody's base expected loss for conduit/fusion transactions was 9.06%, down from 9.07% in first-quarter 2013 because of lower delinquencies and overall better asset performance. Moody's Commercial Mortgage Metrics (CMM) weighted average base expected loss was 7.6%, down from 8.3%. The share of delinquent loans declined to 9.9% from 10.2% in the first quarter, while the share of loans in special servicing declined to 11.5% from 11.8%. Base expected losses will decline slightly as delinquencies continue to decline and loss recoveries improve in tandem with improving market fundamentals.
The overall share of specially serviced (SS) loans decreased 76 basis points to 10.28%, from 11.04% in the first quarter. The share of SS loans contracted 244 basis points from the April 2011 peak of 12.72%, in large part because non-performing, five-year SS loans from 2006 and 2007 are being worked out at a faster pace than new loans have entered special servicing. Lenders modified 59 loans amounting to $1.9 billion. Monthly volume averaged 20 loans and $641.6 million.
Among the individual sector highlights:
The retail sector will post modest gains, with positive rental growth by the end of 2013.
Office market fundamentals are improving gradually and the number of the improving markets is broadening. Depending on regional employment growth, vacancy and rental rates will improve moderately in 2013.
The hotel sector will continue to improve given minimal growth in supply, although the pace is slowing. Revenue per available room (RevPAR) rose 5.0% from the second quarter of 2012, with Luxury Hotels up 6.0% and Urban Hotels up 6.1%. The most improved market performers were San Francisco/San Mateo, CA, and Oahu, Hawaii.
The multifamily sector will remain stable with moderate growth through the end of 2013. The multifamily sector also grew strongly in the second quarter, with the vacancy rate dropping 20 basis points to 4.6%. Six markets currently have vacancy rates lower than 3.0%, among them, Minneapolis, MN, Miami, FL, and Oakland, CA. Effective rent growth rose by an annualized rate of 3.1%, which is solid, but slower than in 2012.
Moody's quarterly US commercial mortgage-backed securities (CMBS) and commercial real estate collateralized debt obligations (CRE CDO) surveillance review reports on recent rating actions, relevant surveillance statistics and topics of interest in the commercial real estate sector from a monitoring perspective. The report is available at https://www.moodys.com/research/Q2-2013-US-CMBS-and-CRE-CDO-Surveillance-Review--PBS_SF337629.
Global investment company Blackstone Group is making a huge wager on housing.While Blackstone is scooping up U.S. and Australian commercial real estate, the tide is turning in Canada:
The group has agreed to buy control of 80 apartment complexes in the US from General Electric, valuing the properties at about $US2.7 billion ($2.94 billion)
The US reports say the deal reflects a gamble by Blackstone that the US residential housing market is on an upswing. Blackstone's real estate arm is its largest operation, and the deal with GE is the company's biggest investment in apartments in recent history.
Blackstone was also said to have made a big bet on traditional homes, spending more than $US5.5 billion to buy houses to rent for now and sell later.
GE, whose finance arm is selling the apartment properties, has been looking to reduce its real estate holdings, as part of an overall effort to reduce its size and risks.
Blackstone is nearing the completion of a deal to buy about $300 million worth of office buildings in Australia from GE Capital.
The assets include 90 Arthur Street in North Sydney, 127 Creek Street in Brisbane and 636 St Kilda Road in Melbourne. GE Capital is also selling a tranche of assets to the Pacific Alliance Group as it focuses on its property lending business.
Following the completion of the long-running sales program, Blackstone will have spent $2.5 billion on Australian property - including shopping centres, office buildings, logistics centres and bulky goods in the past two years.
Its largest single asset is the Top Ryde shopping centre in Sydney and the recently acquired Greensborough centre in Melbourne. It has also been touted as a possible buyer of a hotel portfolio belonging to Brookfield.
In addition, it owns the former Valad Property Group, which has several office assets that could be redeveloped into apartments.
On a recent visit, Blackstone global head of real estate Jonathan Gray said Australia had become a very important market to the group. ''We have moved key people here, we have a platform in Valad, we intend to be big investors,'' Mr Gray said.
''I think we have the foundations of a really good business here.''
Blackstone recently lodged a registration statement in the US, relating to the proposed float of Brixmor Property Group, formerly Centro Properties Group US.
Analysts said Blackstone could raise as much as $US700 million from the sale of 522 US shopping centres it acquired in 2011 as part of its $US9 billion rescue of Centro Properties.
If successful, it would be one of the biggest offers by a shopping centre real estate investment trust since the Simon Property Group's $US840 million float in 1993.
In spite of strong fundamentals, confidence among Canada's commercial real estate leaders continued to wane as go-forward concerns about the Canadian economy, as well as external factors persist. This and other findings were revealed in the Third Quarter 2013 Canadian Real Estate Sentiment Survey released today by the Real Property Association (REALpac) and FPL Advisory Group.Elsewhere in the world, however, there are clear signs that commercial real estate is recovering. In Asia Pacific, commercial real estate is bullish in the first half of 2013:
"Higher interest rates and higher volatility in the equity markets will likely make for more challenging times in the coming year. Perhaps this will lead to a greater separation in values between higher and lower quality assets. This range compressed significantly during the recent period of high liquidity in debt and equity markets," commented survey participant Allan S. Kimberley, Vice Chairman & Managing Director, CIBC World Markets.
The quarterly survey measures the current and future outlook of Canada's top commercial real estate executives on overall real estate conditions, values, and availability of capital. Top-line findings for 2013's third quarter also included:
As participant Larry Dybvig, President, Grover, Elliott & Co., put it: "The expectation of rising interest rates will push capitalization and yield rate requirements up, and that will likely slow transaction activity and flatten asset value trends."
- Interest rate increases over the coming year are seen as inevitable by most and will have widespread implications throughout the industry
- Capitalization and interest rate changes are expected to counteract strong demand for real estate, keeping asset values mostly flat
- Although still seen as available, debt capital is becoming more selective and expensive in response to rising rates
- Equity capital is accessible for the right kind of assets, though there is a concern that a growing number of investors view opportunities abroad as more attractive
In addition, "the markets are cooling as the inevitable rise in interest rates starts to materialize. Many long-term asset owners seem to have taken advantage of historically low rates and have stable portfolios and cash flows, but new and future acquisitions will have to contend with rising rates and a slower market," said Jeff Devins, President, Crestwood Capital Partners Ltd.
Direct commercial real estate investment in Asia Pacific has exceeded market expectations in the first half of 2013, reaching USD 59.7 billion, 21 percent up on the first half of 2012. According to the latest capital markets research by property management and investment company Jones Lang LaSalle, transaction volumes in the region have also increased quarter on quarter, topping USD 32.6 billion in the second quarter of 2013, up 21 percent on the previous quarter.And CNBC reports that according to property services firm Jones Lang LaSalle, Chinese and Korean investors are snapping up commercial real estate in major European countries:
The growth was predominantly driven by the region’s largest markets with Japan, Australia and China all experiencing strong deal flow throughout the quarter.
In Japan, investor confidence has been boosted by improving macro-economic indicators following government stimulatory measures. Acquisitions have been dominated by J-REITs where inclusion in the Bank of Japan’s asset purchase program has supported improved unit prices over the first half of the year.
This, coupled with increased IPO activity, has supported transaction volume growth to USD 10.2 billion in Q2 2013, up 78 percent on the same quarter last year. Over the first half of 2013, volumes reached USD 20.8 billion, 50 percent higher than the first half of 2012.
In Australia, continued demand from both offshore and domestic institutional investors and pension funds lifted transaction volumes to USD 7.3 billion in Q2 2013 and USD 10.5 billion in H1 2013, up 27 percent from the first half of last year. Transaction growth in local currency terms was even higher as the Australian Dollar depreciated against the US Dollar by 13 percent from the 2013 high.
Dr Megan Walters, head of research for Asia Pacific capital markets at Jones Lang LaSalle said: “Capital from around the region continues to show a bias towards core assets; however we are seeing some evidence of a shift towards more opportunistic investment. At the same time, government policy continues to have both positive and negative effects on deal flow, with stimulatory and cooling measures introduced this year.
“Investors are also developing their views around the Federal Reserve’s intention to taper asset purchases, which some believe may happen as soon as the third quarter this year. Longer dated bond yields across a number of Asian markets have moved higher following the announcement, highlighting concerns around the direction of global interest rates.”
Stuart Crow, head of Asia Pacific capital markets at Jones Lang LaSalle said: “We are seeing the results of increased allocations to direct real estate by large global sovereign and pension fund investors. Large US, Canadian and Middle Eastern investors have returned to the region and, together with active Asian high net worth and pension funds, are creating strong demand for assets across the region.
“Japan and Australia, remain particularly active and, given a robust pipeline for the remainder of 2013, will maintain our forecast for transaction volumes to reach USD 110 billion by the end of 2013, which is slightly below the record of USD 120 billion in 2007.
Net capital inflows into Europe's commercial property sector jumped 18 percent in the first half of 2013 compared with the first half of last year to top $12 billion, and Asia-Pacific investors accounted for nearly half that amount at $5.6 billion, Jones Lang LaSalle said.And in the UK, the recovery in commercial real estate is spreading beyond London. One recent deal in Europe worth noting is PSP Investments' joint venture with Britain's Segro for a portfolio of European warehouses:
"Chinese and South Korean investors have driven this growth, especially in the residential and office sectors, and we expect emerging market institutional capital to be a major theme within commercial investment markets for many years to come," Alistair Meadows, director, international capital group Asia Pacific at Jones Lang LaSalle said on Thursday.
Over-exposure to local markets, a build-up of capital and increasing confidence in investing in international real estate were some of the reasons why European commercial property has grown in appeal, said David Green-Morgan, research director, global capital markets at Jones Lang LaSalle.
"They're [Koreans are] moving from a market which is very small to the global market, which is enormous and gives them much more potential," Green-Morgan said. "The euro crisis as a factor has certainly disappeared as a reason not to go to Europe."
Such industrial property typically offers higher yields than offices or shops due to the risks associated with lettings to single tenants in outlying locations that can be difficult to fill should they leave.Smart move by PSP Investments and their real estate team led by Neil Cunningham, one of the nicest and smartest guys I've had the pleasure of working with.
The sector is also expected to benefit from the growth of online shopping which is increasingly dependent on warehouses for distribution.
Canada's Public Sector Pension (PSP) Investment Board, which manages C$64.5 billion ($61.5 billion) of police and army pension money, will contribute 303 million euros ($394 million)of equity for its half stake in the venture, the two said on Friday.
The JV will own 34 properties valued at 974 million euros in countries including France and Belgium and the rental yield is 7.9 percent, three or four percentage points higher than the best offices or shops in central London or Paris.
Norway's sovereign wealth fund formed a 2.4 billion euro joint venture for European warehouses with U.S.-based Prologis (PLD.N) last year.
"It (industrial property) is a perfect asset class in this world of falling bond yields because you have higher yields and letting momentum is actually picking up," said J.P. Morgan analyst Harm Meijer.
PSP Investments and Segro said they planned to grow the portfolio to at least 2 billion euros through developments and acquisitions over the coming years. About 11 percent of PSP Investments' assets, or $7.1 billion, is invested in real estate, with just 3 percent of that in industrial property.
Below, Marcus & Millichap Managing Director Hessam Nadji discusses the commercial real estate market with Scarlet Fu on Bloomberg Television's "Money Moves."