The Return of Commercial Real Estate as a Valued Asset

What a difference a few years – and a steadily improving U.S. economy – have made for investors seeking capital to fund the purchase of commercial real estate.

Industry experts consulted said billions of dollars are available from life insurance companies, private equity funds, REITS, pension funds and other traditional sources to fund the purchase of properties in primary and secondary markets across all asset types. Commercial banks are relaxing underwriting criteria, leading to more capital for investments.

One source summed it up this way: “Investors are being motivated by the hunt for high yields, so currently the market is awash with capital. Real estate has gone from being a very much out of favor asset, to a very much in favor asset.”

Improved market fundamentals here and the prospect of solid income returns put the spotlight on domestic commercial properties as attractive investments in a still-uncertain global economy. In addition, potential turbulence in the stock and bond markets makes hard assets like real estate a better place for investment capital.

Analysts project investment activity throughout the remainder of 2013 will be robust resulting in positive news for practitioners who work in the commercial real estate arena.

U.S. Ranks First In Investment Activity

Transaction data from two leading sources reveal that the U.S. remains the largest and most liquid market globally for direct investment in commercial real estate. Year-end statistics from Real Capital Analytics (RCA) show that in 2012, a total of $293 billion was spent by investors on domestic commercial real estate. Worldwide across all regions (the Americas, Asia Pacific, Europe, the Middle East and Africa), sales totaled $868 billion, meaning the U.S. accounted for 33.7 % of all commercial property sales worldwide. (1)

According to the International Capital Sources – U.S. Inflows Report issued in early 2013 by Jones Lang LaSalle, $163.7 billion was invested in domestic commercial properties in 2012, an 11% increase from the previous year’s totals of $147.1 billion. That figure topped all markets worldwide. For comparison, the United Kingdom ranked second in the international standings the past two years, with $51.4 billion invested in commercial real estate in 2011 and $50.8 billion last year. Germany ranked third with $31.6 billion and $31.2 billion invested in 2011 and 2102, respectively. (2)

First quarter 2013 statistics from the Mortgage Bankers  Association  (MBA)  showed  that  loan originations for U.S. commercial and multifamily properties climbed 9% over the same period of 2012. The increase, according to the MBA, was driven by many more originations for hotel and multifamily properties last quarter, along with a modest increase for industrial property transactions.

The first quarter results reflect a 36% decrease in loan originations from the last quarter of 2012, in what the MBA noted as a “traditional seasonal pattern.” But the numbers show an encouraging trend in origination activity compared to first quarter statistics over the past four years. Consider this comparison: The MBA Origination Index for first quarter 2013 reached a total of 123. In the same period of 2009, it was 40.

Commercial Property Sales Surge In First Quarter

Sources contacted agreed the robust domestic investment numbers will continue throughout the balance of 2013. In our By The Numbers article on page 8, George Raitu, Manager, Quantitative & Commercial Research, explains how the first quarter sales statistics support this contention.

Earlier this year, two major apartment REITS flexed their collective investment muscle with a major acquisition that contributed significantly to the overall investment totals for that investor group. On February 27, Equity Residential and AvalonBay Communities, Inc. closed a $16 billion deal with Archstone Enterprises, LP for the sale of a combined 45,000 apartment units. The Archstone sale reportedly is the largest real estate transaction since late 2007, when private equity firm the Blackstone Group completed its $26 billion purchase of Hilton Hotels.

Other buyers of commercial properties in the January-to-March period include institutions at 16%, with the balance coming from foreign or cross-border investors, end users and other sources, Ratiu said. Regardless, he predicted all investment groups would continue to find commercial real estate a favored investment class for the remaining three quarters of 2013.

“The good news is that we’re ahead of last year, and we can anticipate this year an increase in total investment volume,” he added. “There is a lot of capital in corporate accounts and investment funds seeking opportunities.”

Improving Fundamentals

Two main developments, sources said, helped jumpstart investor interest in commercial real estate assets:

  1. Steadily improving industry fundamentals related to the supply and demand of commercial properties in the years following the 2008 recession.
  2. A rebounding U.S. economy that’s slowly – but steadily– regaining its foothold while many major foreign national economies continue to demonstrate increased signs of instability.

In the years immediately following the recession, vacancy rates soared and rents dwindled. Over the past three years, many markets experienced strong, positive absorption, especially in the multifamily sector; and rents have started to climb back, increasing cash flow. What’s more, many commercial assets are priced right.

“For the most part, commercial real estate is not overpriced right now, except possibly properties in some of the coastal markets,” said Kenneth P. Riggs, Jr., CRE, Chairman and President of Real Estate Research Corporation (RERC). “Plus real estate is a hard asset. It’s a tangible investment that investors can actually see being used. For the long-term investor, commercial real estate provides a solid income return they can count on in the form of rents.”

“Besides, there’s little real competition from the other major investment alternatives,” he continued. “The major swings of the stock market are frightening many investors, bonds and securities are becoming risky since interest rates are expected to rise, and cash is still a poor investment.”

A quarterly survey of institutional investors conducted by RERC supports commercial real estate’s investment value. In first quarter, commercial real estate received a 7.0 rating, far above bonds and cash at 3.6 and stocks at 5.7. In the final quarter of 2012, commercial real estate topped all categories with a 6.7 rating.

And, despite the economic problems still facing the U.S. economy, like the stubborn unemployment rate, the nation remains a favorable place for capital investment when compared to most other countries. Riggs cited benefits that include our strong legal system, availability of market and property data, sound valuations and commitment to transparency in the commercial real estate industry. “This isn’t the case in many other parts of the world,” he said.

A Glimpse Down The Road, And Where The Capital Is Being Invested

The robust investment activity recorded to date was fueled by some of the factors noted above. But how long will the cycle last? Will capital be available for commercial real estate transactions for the foreseeable future, like through the balance of this year?

“I’ll take the long view and say ‘yes,’” said David Rifkind, Principal and Managing Director of George Smith Partners, a real estate investment banking firm based in Los Angeles. “Interest in investing in commercial real estate is increasing – not on a quarter-by-quarter trend – but on a year-by-year trend. Capital is needed  through  2013  and certainly in 2014 because there will be a large wave of refinancing that will be taking place. The peak of that refinancing will take place in 2014 and 2015. There has to be capital allocated to meet those refinancing needs.”

Rifkind said national challenges ranging from the frequent stalemate on Capitol Hill, to slumping consumer confidence to the job market will collectively be a factor in the long-term availability of capital. In this phase of the economic cycle, “We’ll continue to enjoy the benefits of low interest rates a little bit longer and fundamentals are somewhat improving,” he said. “But job growth is everything. It’s the factor we really need to be watching.”

RERC’s Riggs agreed that the unemployment rate is a dominant factor holding back even more positive news regarding improved commercial real estate fundamentals and the national economy. However, the current state of a market in transition has its positive side.

“Commercial real estate tends to attract investors during periods of instability and uncertainty, and I expect the industry to remain a safe haven for investors, particularly those who are investing for the long haul,” Riggs said. “The total return (appreciation and income) is projected to be around 8% for institutional real estate in 2013.”

Commercial properties located in markets with low unemployment rates are being targeted by investors seeking value. Three industries, one expert said, hold the greatest opportunities for job growth.

“Technology, energy and healthcare,” said Marisa Clinton, Director of Capital Markets Research at Jones Lang LaSalle. “Those are the industries that will continue to create jobs in 2013 and beyond. People want to live close to where they work, so commercial real  estate  investments  will follow the markets where there’s a good potential for job growth.”

Clinton said investors are seeking Class A properties in the primary markets like New York, Los Angeles, Washington, Chicago and Boston, but also have targeted some secondary markets, especially in Texas. “Austin right now is off the charts in terms of investor interest,” she said. “And, Seattle and Denver are becoming attractive options. Investors favor real estate now because they are hard assets and can provide a hedge against inflation. They’re looking for high-quality assets that are well located.”

The potential for long-term returns has also attracted interest from a wide range of foreign investors. The JLL International Capital Sources report ranked Canadian sources of capital as the clear cut winner in property sales in 2012 at $8.78 billion to take ownership of 360 properties. Singapore investors ranked second at $2.45 billion spent on 11 properties, and Germany took third with $2.36 billion invested in 24 properties.

“Cross-border capital is very actively pursuing U.S. trophy properties right now,” Clinton said.

NAR’s Ratiu projected cross-border capital will remain constant at around 8% of the total investment sales in the U.S., the same level it has maintained for the past five to six years. “I expect it to stay constant barring any shocks in Europe or any of the emerging markets,” he said. “I don’t think we’ll see a huge change in that mix.”

The Takeaway For The Commercial Practitioner — More Business

Commercial real estate, of course, is a complex market that fluctuates, in part, on a simple economic principle: Supply and demand. When supply decreases and demand increases, rents tend to spike and the marketplace is ready for new construction. Approaching mid-year 2013, rents in most markets have remained constant and developers are waiting on the sidelines for demand to exceed supply.

The increase in commercial activity across many U.S. markets is being fueled by billions of dollars of investor capital seeking better returns through the purchase of existing office, retail, multifamily, industrial and hospitality assets. This market development offers the potential of income growth for practitioners who specialize in many aspects of the industry.

“The number of commercial deals is likely to keep growing through year-end,” Ratiu said. “For the practitioner who is a broker, sales agent or investment manager, growing investment activity leads to more business opportunities and commissions. And, if you’re on the leasing or management side, there’s the potential for higher and more fees.”

More investment volume also may lead to property appreciation, increasing the potential for higher commissions. That’s all great news for REALTORS® who had to work through the market retrenchment caused by the recession four years ago.

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