While real estate investors generally express cautious optimism regarding industry performance in 2005, concerns over the economy and job growth, coupled with the likelihood of higher interest rates, are curbing expectations for a robust year, according to Emerging Trends in Real Estate 2005, recently released by the Urban Land Institute (ULI) and PricewaterhouseCoopers LLP.
At the same time, the report noted that, "interviewees almost without exception are confident that U.S. real estate markets can avoid scenarios that would crater property values."
Emerging Trends in Real Estate 2005 is based on surveys and interviews with more than 500 of the industry's leading authorities and is considered to be one of the industry's longest-running and most-respected annual investment studies. The report anticipates that a key highlight of the coming year will be the race between improving fundamentals (occupancy rates, leasing rates, operating expenses, etc.) and rising interest rates.
"Can real estate supply/demand fundamentals improve enough in 2005 and 2006 to offset the potential negative impact of rising interest rates on property values and pricing? Make no mistake, the race is on," said the report. "For 2005, it all comes back to interest rates, the economy and job growth."
The report cites several factors that could impede economic expansion:
•Federal government budget deficits;
•The balance of trade deficits;
•The weak dollar;
•Unprecedented levels of consumer debt;
•Inflationary pressures from high oil prices;
•Rising employer healthcare costs;
•Uneven job growth prospects;
•Queasiness over terrorism threats;
•Uncertainly surrounding the Iraq War; and
•The possibility of interest rate spikes.
The report notes that most new jobs being created have been concentrated in service industries such as restaurants, temp agencies, retail sales and building servicesniches that "don't fill office buildings or have the earning power to generate growth in other property sectors," said Emerging Trends. Part of the reason is the maturing of America's dominant businessestelecommunication, financial services and pharmaceuticalswhich recently have experienced widespread consolidations in order "to squeeze out efficiencies rather than grow new jobs as in the past."
According to the report, many interviewees are looking to healthcare and biotech to stimulate new job growth, particularly as baby boomers age. Additionally, "advances in high tech should bring the industry out of its bubble-triggered slump," Emerging Trends noted.
While the report points out that Internet technology has greatly reduced the need for office support staff and expensive headquarters space, Emerging Trends also reported that many interviewees dismiss the recent public discussion concerning offshore outsourcing as "overblown media hype."
In the words of one REIT executive quoted in the report, "The economy is in transition and off-shoring is a moderator of growth. It is not as dismal as the alarmists predict, but it is part of the current lag and may be stalling some of the near-term acceleration."
Emerging Trends survey participants increasingly voiced concern over Americas schools and their ability to educate students to adequately compete in a rapidly evolving global economy that places a premium on math and science skills.
"We need to do better if we are to maintain our edge and keep creating high-level, high-paying jobs at home," said an interviewee.
Emerging Trends, now in its 26th year, examines the outlook for real estate capital markets and contains a comprehensive annual forecast for all categories of the commercial real estate industry, including apartments, regional malls, downtown offices, warehouses, community shopping centers, suburban offices, research and development space, power centers, full-service hotels and limited-service hotels. This year, the report also tracked trends in the housing industry. In its "Markets to Watch" category, Washington, D.C., New York City, southern California and south Florida ranked as the top investment markets.
"Big money continues to go bicoastal," said an interviewee. "Middle America is a hard sell ... smaller markets must make do on local country club money."
The top markets, noted the report, all feature international gateways with physical growth barriers, solid economic underpinnings and are magnets for immigrant labor. As for specific characteristics making each favorable, Washington, D.C. is considered a "government mecca" practically immune to economic downturns; New York remains a world hub for finance and culture; southern California has a strong mix of entertainment, defense and biotechnology industry; and south Floridaspecifically Miamiis benefiting from both a baby boomer influx and proximity to South and Central America.
"As technology and global capital flows integrate economies and industries across national borders, cities and markets enjoy better prospects if they can link their fortunes to the evolving international growth path," said the report. "The deck is increasingly stacked against a Kansas City, Milwaukee, or Indianapolis, which pale in comparison to American powerhouse markets, but also faces difficulties competing to attract commodity jobs in offshore face-offs against Dublin, Manila or India."
Despite having expanding populations, Dallas, Houston and Atlanta lose support among investors, due to unrestrained development and poor growth management, says Emerging Trends, noting that the desire to avoid long traffic commutes gives an advantage to markets with mass transportation networks. In general, the success and resilience of the most attractive investment locations can be attributed to 24-hour market characteristics such as upscale infill neighborhoods near commercial districts, convenient pedestrian-friendly retail, ample recreational and cultural amenities and ample transit options, according to the report.
For 2005, survey respondents predict that real estate will outperform stocks (67 percent said yes, 33 percent, no) and bonds (96 percent, yes, four percent, no.) They also forecast that private real estate has the best asset class investment potential, ahead of domestic stocks and public real estate. In the worst case, should the economy tank from a geopolitical crisis or terrorist attack, interviewees do not believe that property markets will suffer a greater decline than stocks or bonds.
Regarding development opportunities, the report noted that although commercial construction could pick up from this years dormant levels, prospects remain restrained.
"Until markets achieve better supply/demand balance, investors are more focused on buying land, gaining entitlements, and planning projects rather than funding construction," said Emerging Trends. However, the outlook for housing development remains far more promising with infill and in-town housing again topping the survey development scorecards. While the move back downtown by empty nesters and childless professionals "cannot be ignored," demand should hold steady for suburban single-family housing "as long as interest rates remain manageable," the report said.
"Master planned and New Urbanist communities tap into rising homeowner demand for neighborhoods featuring more integrated land uses and access to convenient amenities. People seem willing to pay premiums for better planning."
For more information, visit www.uli.org.