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National Mortgage Professional
Jun 18, 2008

PricewaterhouseCoopers Korpacz Real Estate Investor Survey sees fluctuation in commercial marketsMortgagePress.comPricewaterhouseCoopers Korpacz Real Estate Investor Survey, commercial real estate The U.S. commercial real estate market's downturn continued in the second quarter of 2008, hurt by a weak economy, the credit disruption, tepid tenant demand and a wide pricing gap, according to the latest edition of the PricewaterhouseCoopers Korpacz Real Estate Investor Survey. A plunge of as much as 81 percent in the sales of some types of commercial property, an increase in average overall capitalization rates for many markets, a slip in the rental market and a decrease in initial-year market rent change rates accounted for much of the downturn during the quarter, according to the quarterly survey of major institutional equity real estate investors. Investors' uncertainty about the direction of the economy added to the woes. With job losses mounting and consumer confidence waning, prospective buyers were unwilling to meet sellers' pricing levels, widening the pricing gap. Many investors believe that the disparity in prices is unlikely to narrow again until there are stronger signs of economic prosperity and liquidity returns to the industry. "The pricing gap that resulted after the credit markets tightened has been further widened as a result of most real estate investors now taking a back-to-basics approach and being more conservative than sellers in their underwriting," said Tim Conlon, partner and U.S. real estate sector leader for PricewaterhouseCoopers. "Investment opportunities still exist, and there are still buyers out there willing to take advantage of good opportunities." While the majority of nationwide markets are mired in an economic slowdown, investors realize that the commercial real estate fundamentals are healthier than they were during the last downturn in the mid-1990s. New construction is being restrained, supply and demand is more balanced and cash flow assumptions are more realistic, laying the groundwork for a rebound when the economy gathers steam. For the time being, the "fundamental" investor has replaced the leveraged investor. "On the buy side, real estate investors are no longer betting that properties will experience tremendous increases in rental income and value and that is why the pricing gap between buyers and sellers took center stage in the past quarter," said Susan M. Smith, editor-in-chief of PricewaterhouseCoopers Korpacz Real Estate Investor Survey and a manager in the PricewaterhouseCoopers real estate sector services group. "We are definitely in a downturn, but investors are finding comfort from the notion that the fundamentals are still quite healthy, positioning the industry for recovery once the economy begins to turn around." Property types and locations are displaying different trends, the survey showed. Strong investment interest is buoying prices of high-quality assets in top-performing markets despite a drop in transactions, reflecting a "flight to quality." In secondary and tertiary markets, price declines and cap rate expansions are most noticeable. A large pricing gap and lack of leverage led to a massive decline in sales volume in the four major commercial property sectors on a year-over-year basis during the second quarter of 2008. Transactions involving significant office, apartment and retail properties plunged by at least 79 percent in April compared with a year earlier, while industrial sales fell the least, by 67 percent. As the industry continues to transition, it is increasingly favoring buyers. In the national suburban office market, for example, a total of 27 percent of investors said market conditions now favor buyers, a four-fold increase from 2007. Nevertheless, foreign buyers, supported by a weak dollar, remain focused on acquiring assets in the U.S. In fact, the survey reveals that Middle Eastern and Australian investment now outstrips that of Germany, and there is a steady flow of new buyers from all over Europe. On a year-over-year comparative basis, the average overall capitalization rate for an increasing number of surveyed markets showed an uptick between the second quarter of 2007 and the second quarter of 2008, according to the poll. Individual office markets that witnessed the largest year-over-year increases in average overall capitalization rates include Phoenix, Suburban Maryland and Northern Virginia. The biggest increases in overall capitalization rates are forecast to occur in the national regional mall market, as well as the Houston and Northern Virginia office markets, according to estimates. On average, overall capitalization rates for all the markets surveyed are expected to increase about 35 basis points over the next six months. The commercial rental market, while still a bright spot in U.S. real estate, has dimmed recently. Vacancy rates are inching up across all property sectors, and rental growth is slowing. In the second quarter, the initial-year market rent change rate declined in 14 of 18 office markets in the survey, twice as many as in the fourth quarter of 2007. The survey shows that few dominant office markets are bucking this trend. Manhattan's initial-year market rent change rate fell for the third quarter in a row after an average quarterly gain of 161 basis points in the preceding 12 months. In San Francisco, the initial-year market rent change rate dropped 228 basis points in the second quarter. "It's now clear that problems in the residential housing market, which is undergoing its most serious downturn in two decades, and a slowdown in U.S. economic growth have spilled over into the commercial real estate market," said Smith. According to the survey, the office market in cities including San Francisco, Philadelphia and Fort Lauderdale, Florida, are in contraction. Other Florida cities, including Miami, Tampa and Jacksonville, are declining, as are San Diego and Sacramento, California. Few major office markets are expanding. The exceptions include Honolulu and Hartford and Stamford, Connecticut. In Los Angeles, which has mostly bucked industry declines, investors expect office property values to rise an average of 2.6 percent during the next 12 months, more than in the first quarter of 2008. Other markets expected to realize strong value growth, on average, over the next 12 months include Manhattan at 5.6 percent, Denver at 4.0 percent and Southeast Florida at 3.2 percent. In contrast, investors expect office property values, on average, to decline in the office markets of Charlotte (-5.0 percent), Chicago (-1.3 percent), and Northern Virginia (-0.1 percent). For more information, visit www.pwc.com.
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