Magazine article Real Estate Issues

Focus on Investment Conditions: Investors Work at Separating the Wheat from the Chaff

Magazine article Real Estate Issues

Focus on Investment Conditions: Investors Work at Separating the Wheat from the Chaff

Article excerpt

Like much of the rest of the nation, Real Estate Research Corporation (RERC) continues to watch for signs that the economy is strengthening. Unemployment increases seem to be slowing, and the stock market appears to be gaining momentum. Low interest rates continue, keeping the housing industry chugging along while providing the economy with a boost and giving consumers either more housing choices or more dollars to save or spend elsewhere. Most analysts believe that consumer spending will increase and business hiring will increase as the various new tax credits and incentives come into play.

With a more positive outlook for the economy, investors are hoping to see some signs of improvement in the demand, or tenant side of the commercial real estate market equation, too. Investor unease as investment dollars grow and flow into a deteriorating space market would be put to rest if at least the space markets would move in tandem with the capital markets. This easing of the disconnect will not happen quickly through demand fundamentals, as we must remember that real estate lags the economy by 6 to 12 months and it will be some time before definite improvement is seen in this investment class. There are certainly opportunities for well-leased properties with solid fundamentals and in good locations, but in general, total delivered returns have not met expectations.

RERC has noted during the last few quarters, that institutional investors have begun lowering their total return expectations to match the financial markets and the observed signals being sent by investors trying to get deals done in the commercial real estate market. In fact, in the summer 2003 RERC Real Estate Report, "Separating the Wheat From the Chaff," RERC reported lower expected pre-tax yield rates for all property types than any time during the last two years. Realized returns (returns reported by NCREIF) remain in the single digits as property values are being realigned to reflect the future market prospects.

A comparison of required total returns vs. realized total returns reflects that the two have yet to meet at a market equilibrium point. The confluence of pressures to push required total returns down and realized total returns up is at work, but these dynamics move too slowly in a technology-flush world that desires real-time information popping up on the screens of investors. We are in that frictional period where re-pricing revaluations, and expectations change relatively slowly in a monolithic industry. The data is showing that slowly, over time, expectations are coming down, but most investors are vocal that they are too high to get deals done.

Over a 10-year average, all property types, except apartments and industrial R&D, show a negative variance between required total returns and realized total returns. Five-year returns look better, with industrial R&D properties, CBD offices, apartments, warehouses and power centers showing a positive variance between required and realized returns. Suburban offices, neighborhood and community centers, regional malls, and hotels, show negative variances between required and realized returns for a five-year time period.

However, a comparison between required total and realized total returns over the past one-year time period demonstrates that real estate expectations clearly are not matching market realities and shows how wide the current disparity is between sellers and buyers among all property types:

CBD office properties are showing a -6.17 percent one-year average variance between required total and realized total returns, and suburban office properties show a -10. …

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