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ULI: EXPECT A MORE WIDESPREAD RECOVERY IN COMMERCIAL REAL ESTATE IN 2013

DENVER — 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. That's the conclusion of Emerging Trends in Real Estate 2013, an annual forecast released Wednesday by PwC US and the Urban Land Institute (ULI).

The Emerging Trends survey results were based on interviews and survey responses from more than 900 leading real estate experts, including investors, fund managers, developers, property companies, lenders, brokers, advisers, and consultants.

Despite a slower than normal real estate recovery, U.S. property sectors and markets will register noticeably better prospects than in 2012, according to survey participants.

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.

Even the housing sector will make 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 respondents,” says Mitch Roschelle, partner and U.S. real estate advisory practice leader at PwC.

“As yields 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,” emphasizes Roschelle.

Stephen Blank, ULI’s senior resident fellow for real estate finance, notes 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,” says Blank. “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 survey forecast indicates 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 concentration on leasing to high-quality tenants within growth industries that are sustainable.

However, as property prices meet or exceed pre-recession levels in the cities of 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 tick up with more action in 2013. Pricing is forecast 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:

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 look in 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 these markets, 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.

Markets to watch

The most favored markets for investment are hardly a surprise. A snapshot of the top 10 markets ranked by survey respondents and their outlook for each of the markets is below:

1. San Francisco — In 2013, San Francisco steals the Triple Crown from Washington, D.C., receiving top billing in the Emerging Trends investment, development, and housing categories. The market is driven by growth and a strong jobs outlook, led by technology and a structural change away from suburban and toward downtown. Continued infill interest is supported by one of the best transit systems in the country and a city center with walkability that is number two only to New York City.

2. New York City — New York City makes a small move this year, stepping up two spots to second best investment prospect. However, investors still seem concerned about the run-up in prices. Demographics for the city prevail, with 20 percent of jobs being in the growing education and health care sectors and an important echo boomer population. Service-type jobs continue to develop, but a lag in goods-producing jobs is a concern.

3. San Jose — The San Jose technology corridor continues to be a market to watch. In 2013, San Jose and the broader Silicon Valley are largely expected to generate jobs in a variety of fields, but most will revolve around the high technology firms. Industrial diversity is limited in San Jose and could be a concern for investors. However, the more than 6,600 technology companies based here employing more than 225,000 people make it an area of interest.

4. Austin — In 2013, Austin looks set to extend its trend of attracting individual and institutional investors alike. Expansion of commercial real estate in Austin looks likely with a population increase of 2.3 percent anticipated next year, pushed by the echo boomer demographic.

5. Houston — Energy-related employment is one of the driving forces behind the Houston market, and the investment prospect rank jumped from eighth to fifth. Survey participants believe the main buying opportunities are in the industrial sector. Fifty percent believe that space in Houston is worth taking a chance on.

6. Boston —An increase in high-tech and biomedical research drives this market, increasing investor interest.

7. Seattle — This city is the global center for the software industry and continues to be the focus of many domestic and global investors.

8. Washington, D.C. — Commercial real estate prices have risen since the recession, with investors regarding D.C. investments as “recession-proof.” However, concerns about overbuilding and costs continue to lead discussions about interest in D.C.

9. Dallas/Fort Worth — This major metro ranks behind only Houston as a job provider, and the Dallas/Fort Worth job base is one of the most diversified of the 51 markets covered.

10. Orange County, Calif. — This area shows increases in rating value and ranking as an investment prospect.

Outlook by property type

The Emerging Trends investment ratings show that the apartment sector is still on top, though noticeably leveling off. Retail continues to lag, but is recovering. Industrial/warehouse and hotels show the biggest survey improvements, trailed closely by downtown office.

Power centers and suburban offices remain investors’ least-favored subcategories. Except for apartments and industrial space, development prospects remain challenging. Interviewees show mixed concerns about apartment construction on a market-by-market basis, but generally concur that overdevelopment will occur, just not in 2013. They also anticipate more big-box industrial development.

Content Partners
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‣ Lee & Associates
‣ Lument
‣ NAI Global
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‣ Walker & Dunlop

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