U.S. Commercial Real Estate Sector Recovery to Advance Further in 2013
The real estate recovery is set to advance in 2013, as modest gains in leasing, rents and pricing will extend across U.S. markets from coast to coast and improve prospects for all property sectors. Those are some of the findings of the “Emerging Trends in Real Estate 2013” report, released in mid-October by PwC US and the Urban Land Institute. ULI hosted its annual fall meeting in Denver Oct. 16 – 18.
According to survey participants, despite a slower-than-normal real estate recovery, U.S. property sectors and markets will register noticeably better prospects compared to last year. Recent job creation should be enough to increase absorption and push down vacancy rates in the office, industrial, and retail sectors, helped by the limited new supply in commercial markets. Robust demand for apartments should hold up, survey respondents indicate, even as new construction ramps up—and even the housing sector makes progress in most regions. Additionally, improving fundamentals should help with rents and net operating incomes, building confidence about sustained growth and strengthening recent appreciation.
“With the outlook for commercial real estate continuing to improve in 2013, investors are expected to allocate substantial sums of capital to the real estate asset class, according to our survey respondent,” said Mitch Roschelle, partner, U.S. real estate advisory practice leader, PwC. “As yield on bonds and other financial instruments tighten in a still volatile market, commercial real estate’s income-producing and total return attributes offer investors potentially attractive risk-adjusted returns.”
Stephen Blank, ULI’s senior resident fellow for real estate finance, noted that investors must keep in mind recent progress made in the industry as they prepare for a slow but steady recovery.
“What these findings suggest is that, in general, the industry is moving forward bit by bit. Nothing indicates a quick turnaround for commercial real estate, but it is improving. Those who are patient and willing to rethink their expectations and adapt to market realities are the most likely to come out ahead next year.”
Capital Chases Yields
Despite macro-economic concerns, the 2013 Emerging Trends forecasts that investors will return to greater risk taking in their portfolios in an attempt to gain more yield. Even as riskier secondary markets show up on investors’ radars, many believe the move cannot be made without a concentration on leasing to high-quality tenants within growth industries that are sustainable.
However, as property prices meet or exceed prerecession levels in San Francisco, New York City, Boston, Washington, D.C., Los Angeles and Chicago, the focus of property investors has shifted more to the lessee’s value, various market demographics, a city’s economic production, diversification, job growth and where people want to live.
According to the report, investment capital’s interest in commercial real estate is expected to increase as other asset classes continue to offer minimal returns or too much volatility. In fact, Emerging Trends found that only six of the 51 markets covered exhibited a decline in investment prospects.
Transaction volume is expected to move upward, with more action in 2013, according to Emerging Trends. Pricing is predicted to strengthen, but increases will be muted until credit markets return to more normal states. Commercial mortgage–backed securities (CMBS) may return to the financing spotlight once transaction activity increases. Interviewees expect that CMBS issuance can return to a $75-billion to $90-billion level over the next several years.
Respondents to Emerging Trends cite a number of best investor bets for 2013, which include:
• Concentrate acquisitions on budding infill locations. Top urban markets outperform the average, bolstered by move-back-in trends and Gen-Y appeal. Top core districts in these cities have become too pricey, so seek districts where “hip” residential neighborhoods meet commercial areas. Construct new-wave office and build-to-core in primary coastal markets. Major tenants willingly pay high rents in return for more efficient design layouts and lower operating costs in LEED-rated, green projects.
• Develop select industrial facilities in major hub distribution centers near ports, rail corridors and international airports: In thesemarkets, the industrial sector is driven by tremendous demand by large-scale users looking for specialized space and build-to-suit activity.
• Use caution investing in secondary and tertiary cities. Focus on income-generating properties and partner with local operators who understand tenant trends and can leverage their relationships. Markets grounded in energy and high-tech industries show the most near-term promise, while places anchored by major education and medical institutions should perform better over time.
• Begin to back off apartment development in low-barrier-to-entry markets. These places tend to overbuild quickly, softening rent growth potentially and occupancy levels probably by 2014 or 2015.
• Consider single-family housing funds. Housing markets finally get off bottom and major private capital investors make a move into the sector. Concentrate investments with local players who know their markets and can manage day-to-day property and leasing issues.
• Repurpose the oversupply of obsolescent properties. Whether abandoned malls, vacant strip centers, past-their-prime office parks, or low-ceilinged warehouses, an overabundance of properties requires a rethink, a teardown, and, in many cases, a new use.
Job Producers & Echo Boomers
During recessions, some investors have sought more economically diverse markets to weather job losses and declines. However, now, in a time of slight economic uptick, Emerging Trends results indicate that investor sentiment is focused on job-producing industries and those markets that contain them, regardless of how diverse the businesses are that are producing those jobs.