Market failing to give in to gloom-and-doom predictions

Real Estate Weekly,  Oct 17, 2007  

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While much of the media seems transfixed by the reported meltdown in the nation's housing market, underlying fundamentals remain relatively strong across most sectors of the commercial real estate industry, according to the newly released PricewaterhouseCoopers 3Q 2007 Korpacz Real Estate Investor Survey.

"Despite a slowdown in employment growth and a slight rise in the U.S. jobless rate, the national central business district (CBD) office market continues to perform strongly," said Susan M. Smith, editor-in-chief, PricewaterhouseCoopers Korpacz Real Estate Investor Survey.

At the same time, strong investment demand and favorable underlying fundamentals are keeping buyers and sellers very active in the national suburban office market, she noted.

"There's no question there has been some negative impact as a result of the problems arising from the subprime residential market downturn," said Tim Conlon, PricewaterhouseCoopers' U.S. Real Estate Sector Leader.

"That said, while the volume of investment levels has slowed, the gloom-and-doom scenarios predicted for the commercial real estate market have yet to materialize and the underlying fundamentals continue to be fairly strong."

The quarterly survey of professionals involved with the real estate industry, including institutional investors, REITs, pension funds, mortgage bankers, developers and insurance companies, identifies trends across key real estate industry sectors. Other notable findings include:

* Investment demand for CBD office assets should remain strong, especially for Class-A properties located in major U.S. coastal cities, such as New York, San Francisco, Seattle and Washington,DC.

* "Condo reversion" activity--properties previously converted to condos, which are now returned to the rental market--is undermining the health of the apartment market in a number of regions.

* Transactions involving strip shopping centers have been quite voluminous during the past few months, mainly due to an increase in corporate mergers and acquisitions. Including privatizations, more than 1,600 strip centers traded for $5 million or more during the first six months of 2007.

Additional findings, by sector, include the following:

Retail: Despite apparently solid interest from would-be investors, a lack of quality offerings is limiting acquisition activity in the national regional mall market, as many of the best-performing regional malls are owned by top public owners and are rarely traded. Those that do come up for sale are quickly and aggressively acquired. At the same time, lifestyle centers are increasingly sought after by investors, with the transformation of existing regional malls into lifestyle centers and/ or mixed-use properties being seen as ongoing trends.

Investors also are showing strong interest in national power center assets as numerous bigbox and discount retailers continue to perform well--despite a slowdown in consumer spending caused by higher interest rates, eroding credit quality and larger levels of consumer debt. A number of investors, in fact, are looking toward new construction as an alternative to acquiring existing power center assets.

In the national strip shopping center market, the pace of transactions has been steady due to ongoing M&A (merger and acquisition) activity, although a slowdown in Coasts of the U.S.

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In the national suburban office market, strong investment demand and solid fundamentals are encouraging a high level of activity among buyers and sellers. As a result, a number of investors predict that sale prices will continue to increase especially for top-performing suburban office markets, such as Portland, Southern California, Boston and St. Louis. Flex/R&D: Investors in the national flex/R&D market are seeing added interest from would-be suburban office tenants searching for competitive alternatives in the face of tighter vacancy rates and rising rents in the national suburban office market.

In fact, in many West Coast suburbs, such as San Diego and Orange County, vacancy rates for flex/R&D are lower than traditional office vacancy rates. For example, in San Diego, flex/R&D space posted a vacancy rate of 8.9% in the second quarter of 2007, compared to a rate of 10.9% for the office sector.

Warehouse: Despite demonstrating some initial weakness at the start of this year, underlying fundamentals for the national warehouse market are again showing strength.

Dominant warehouse markets continue to line both the East and West Coasts and include Los Angeles, San Diego, Miami, Tampa, and Northern New Jersey.

Vacancy rates for these top-performing markets range in the low single-digit range and present challenges to existing and prospective large-space users. Healthy fundamentals across much of the national warehouse market continue to lure investors who like the steady returns and appreciation rates typically offered by this sector.