Through the Looking Glass
The market outlook isn’t half bad.
Americans struggle with the realities of a new normal — including slow economic
growth, a $16 trillion debt load that has prompted new warnings by the major
credit rating agencies, volatility throughout the world, and waning job growth
— it is hard not to become discouraged about the state of the national economy
and the outlook for all investments. The Federal Reserve has done nearly everything
it can to spur growth, and Chairman Ben Bernanke has announced the Fed will buy
$40 billion of mortgage-backed securities every month until the job market
improves. But monetary policy alone cannot get the U.S. out of the hole it is
in, and no matter how much we polish our looking glass, a new fiscal policy is
unlikely to appear much different from what we have seen in the past.
Reflections on the Recent Past
to the past gives us our best view of what to expect in the future. With
respect to the national economy, Real Estate Research Corp. expects to see the
sluggishness we have endured for the past several years to continue. Slow
economic growth in the neighborhood of 2.0 percent, weak job growth, still-low
interest rates, and volatility in the stock market are expected in 2013.
lethargic employment growth, the low interest rates in this investment
environment continue to favor safe investments, particularly commercial real
estate. CCIM members who responded to RERC’s 3Q12 Investment
Trends Quarterly survey gave commercial real estate
their highest investment rating of 6.1 on a scale of 1 to 10, with 10 being
high, followed by a rating of 5.4 for stocks, 4.5 for cash, and 4.3 for bonds.
1 shows that year-to-date returns for the major stock market indices had
increased significantly at the end of 3Q12. Although stock market returns
continue to fluctuate, overall real estate returns have remained relatively
stable. As determined by the National Council of Real Estate Investment Fiduciaries
in the NCREIF Property Index, real estate returns will likely remain close to
the averages shown.
for the future, the relative safety of commercial real estate as an asset class
is likely to continue to be critical for investors in the year ahead. Real
estate is tangible and transparent, and it offers reasonable returns as an
investment alternative, particularly in periods of volatility, which we expect
as long as the challenges in the national economy continue. We are starting to
see required pre-tax yield rates and going-in capitalization rates decline
slightly for the office, industrial, and neighborhood/community institutional
retail markets (see Table 2). However,
compared to 10-year Treasuries (see Figures 1 and 2), commercial real estate returns
should remain relatively stable.
Coming Clean in 2013
most part, commercial real estate has come clean: It has been re-priced
appropriately and values are reasonable. Commercial property in the primary
markets, particularly the coastal markets, is fully priced. In addition, lack
of confidence and volatility in the stock markets, low bond yield rates, and
low interest rates continue to favor the commercial real estate market as an
addition, most cities and states have made the kinds of adjustments required to
get their fiscal position in order during the past couple of years. Many
regions and markets have successfully set priorities, made difficult but
necessary decisions, and balanced their budgets. We saw increasing numbers of
commercial property transactions in secondary and tertiary markets throughout
2012. This trend should continue due to the general improvement in regional
economies, which has been boosted by local manufacturing, improving job growth,
and stabilizing home prices. Further, commercial property re-pricing is taking place in these markets and distress continues to be
resolved, which should continue as long as interest rates remain low.
members have also noted the strength in the regional economies compared to the
national economy, and rated their regional economies accordingly in 3Q12. The
East regional economy earned the top rating of 6.1 on a scale of 1 to 10, with
10 being high, followed by the West with a rating of 6.0. The South regional economy
was rated at 5.6, and the Midwest at 5.3. In contrast, the national economy was
rated at 4.9 during 3Q12.
weak job growth, vacancy in the major commercial property sectors has continued
to improve during the past year. In the national market, apartment sector
vacancy has declined 100 basis points since 3Q11, compared to the retail sector
where vacancy has declined only 20 basis points in the same period. Rental
growth has been mostly flat throughout the year, except for the apartment
sector, where apartment rent has increased so much that we are again seeing the
cost benefits of buying a home versus renting. In addition, 3Q12 total sales
volume of commercial property decreased year-over-year on a 12-month trailing
basis, with less volume noted primarily in the office, retail, and hotel
The office sector’s vacancy declined to 17.1 percent in 3Q12 from 17.4 percent
a year earlier, according to Reis. Absorption was positive throughout the year,
although asking and effective rents increased only slightly (approximately 35
cents to 50 cents per square foot on average). The total volume of office
properties declined to $60.2 million on a 12-month trailing basis in 3Q12,
which was lower than a year ago and compared to the previous quarter’s volume,
according to RERC’s transaction analysis. The size-weighted average price
dropped to $177 psf on a 12-month trailing basis.
The industrial sector’s availability rate fell to 13.1 percent during 3Q12,
which is the ninth consecutive quarter in which the industrial availability
rate has declined, according to CBRE. Total sales volume of industrial
properties increased slightly to more than $30.7 million in 3Q12, higher than a
year ago and the previous quarter’s sales on a 12-month trailing basis, per
RERC’s transaction analysis. In addition, the size-weighted average price of
industrial space increased to $55 psf on a 12-month trailing basis.
The retail sector’s vacancy remained at 10.8 percent in 3Q12, down only 20
basis points from 3Q11. Asking and effective rents for neighborhood and
community centers were flat, increasing an average of only 8 cents psf over the
year, according to Reis. However, this is the first year since the recession
began that absorption was positive during each quarter. RERC’s transaction
analysis shows that 12-month trailing total retail sales volume decreased to
$40.5 million in 3Q12, which was down from YOY volume and from prior-quarter
volume. The size-weighted average price of retail space decreased to $136 psf
Although fundamentals continue to improve for the multifamily sector, volume
and price declined in 3Q12. The vacancy rate for the apartment sector declined
to 4.6 percent during 3Q12 compared to 5.6 percent a year ago, according to
Reis. Net absorption began to slow, but asking and effective rents increased
$35 to $40 per unit during the year. According to RERC’s transaction analysis,
total transaction volume for the apartment sector decreased to nearly $56.8
million in 3Q12 on a 12-month trailing basis, which was higher than year-ago
volume, but less than 2Q12 volume. The size-weighted average price per
apartment unit increased to $90,848 on a 12-month trailing basis, which was
higher than the year-ago average price but lower than the 2Q12 price.
Third-quarter 2012 hotel sector occupancy rose to 64.2 percent, a 2.5-percent YOY increase, according to Smith Travel Research. The average daily
rate was up 5.4 percent to $106.60, and revenue per available room increased
8.0 percent to $68.43. However, RERC’s transaction analysis indicates that
total sales volume for the hotel sector declined to more than $12.3 million on
a 12-month trailing basis in 3Q12, which was lower than both year-ago volume and
prior-quarter volume. The price for hotel rooms also declined compared to both
year-ago and previous-quarter pricing, with a size-weighted average price per
unit of $89,832 on a 12-month trailing basis in 3Q12.
Secondary and Tertiary Markets:
Better Times Ahead
respect to commercial real estate returns in the secondary and tertiary
markets, Charlotte, N.C., has seen total returns of 13.55 percent and income
growth of 6.99 percent during the past year, according to RERC’s analysis.
Apartment vacancy declined 180 basis points during the past year in Charlotte,
with effective rental growth increasing approximately 3.5 percent, according to
Reis. Industrial sector vacancy declined 30 basis points and saw 2.16 percent
effective rental growth over the past year, while retail sector vacancy
declined only slightly and effective rental growth increased 0.51 percent. In
contrast, office sector vacancy increased slightly and rental growth was
is another market that is seeing a positive transformation, with total returns
of 6.27 percent during the past year, primarily based on the improvement in
capital returns from -8.24 percent during the past three years to only -1.9
percent in the past year. In addition, income growth has increased consistently
during the past few years to 6.16 percent during the past year, according to
RERC’s analysis. This market has also been led by meaningful vacancy declines
and effective rental growth increases in the apartment and industrial sectors.
Retail vacancy also improved, although effective rental growth remained flat,
while office sector vacancy increased and rental growth was weak.
a decline in total returns to 4.25 percent in 2012 from 6.72 percent in 2011,
per RERC’s analysis, the income growth in Columbus, Ohio, rose to 9.45 percent
this past year. Property performance generally followed that of the Cleveland
market, but because of the change in income and a decline in office vacancy,
this metro offers better investment opportunity.
metropolitan regions that are starting to pull out of the mire include Las
Vegas, with a net change in income growth of 1,100 basis points, the largest
growth of any of the top 48 metro regions. Even Detroit, which has been heavily
undervalued in the past, has shown continually increasing income.
some of the safer markets, total returns increased 12.09 percent over the past
year in Nashville, Tenn., with even the office sector showing improvement.
Houston and Denver are showing solid income growth, and the office sector,
which is the most underperforming sector, is seeing declining vacancy and
increasing effective rental growth. In addition, Minneapolis appears to have
good growth potential from a capital returns perspective.
An Improved View of Risk
and uncertainty continue to dominate the investment environment, relatively
safe and solid investments will continue to earn lower yield as noted by the
nearly nonexistent returns for Treasuries or cash holdings. That is partly why
commercial real estate, with its reasonable income returns and potential for
growth, is attractive as a long-term investment.
the relatively strong fundamentals and stability of this asset class,
commercial real estate is not without risk, given its dependence on job growth
and other economic factors. However, as illustrated in the fundamentals, total
returns and income on this asset class are slowly improving, and more
importantly, CCIM members expect this trend to continue. CCIM members gave
commercial real estate an overall return versus risk rating of 5.5 on a scale
of 1 to 10, with 10 being high, in 3Q12, as this asset class gained appeal
(Table 3). When looking at the individual property sectors, the safest property
types earned the highest return versus risk ratings, such as the apartment
sector with a rating at 7.2. At 4.9, the office sector has the lowest return
versus risk rating, indicating that there is slightly more risk involved with
we have seen over the past few years, commercial real estate can be the refuge
investors need as they peer into the looking glass, seeking relative safety and
reasonable returns. However, for investors to make the best use of the real
estate looking glass, close scrutiny of the facts and fundamentals, proper
illumination of the investment environment overall, and an objective look at
the reflection peering back are needed.
Kenneth P. Riggs Jr.,
CCIM, CRE, MAI, is chief real estate economist for CCIM Institute and chairman
and president of Real Estate Research Corp. in Chicago. Contact him at