2014 Midyear Market Review
We’re only halfway up the mountain.
January, Integra Realty Resources released Viewpoint 2014, reflecting our
national assessment of real estate market cycles throughout 63 primary,
secondary, and tertiary U.S. markets. These preliminary results of our midyear
update highlight forecasts for markets with solid investment fundamentals for
the balance of 2014.
assessing the midyear market, first consider some key trends that affect the
national commercial investment market.
to the financial services industry will reduce near-term commercial leverage.
The U.S. real estate markets are tightly coupled with one another due to
underlying structural changes in banking and finance. It began with the forced
bank consolidation during the savings and loan bailouts of the 1990s and has
now reached a critical mass with “too big to fail” institutions resulting from
the massive federal bailout of the U.S. banking system in 2008 and 2009.
According to the most recent FDIC report, 21 banks out of the total 6,812 U.S.
banking institutions hold $7.8 trillion in assets of the total $12.7 trillion
asset base. In other words, a mere 0.3 percent of the banks manage 61.7 percent
of the assets. Another 86 banks hold an additional 18 percent of assets and
make up only 1.2 percent of the total institutions. Thus, 80 percent of the
total U.S. asset base is held by fewer than 107 banks out of 6,812 total
institutions. The balance of the banks have assets of less than $10 billion and
represent about 20 percent of the total asset base.
regulatory changes, small and midsize institutions remain under extreme cost
pressure to consolidate. While the number of institutions continues to decline
quarterly, FDIC analytics indicate continued strengthening of bank balance
sheets. The number of banks will decrease for the balance of 2014 primarily due
to consolidation, not bank failure, because core asset values (residential and
commercial investment real estate) continue to improve.
survey of IRR offices indicate that the close of first quarter 2014
demonstrated much weaker lending pipelines and increased competition by banks
for viable commercial deals. The bulk of the refinancing activity from 2012 and
early 2013, which fueled the banking recovery, now appears to be slowing. This
will likely have negative implications for lending volumes (and hence bank
profitability) for the balance of 2014.
this is a healthy correction as asset values have recovered from the
recessionary trough in all U.S. markets. The reality is that we’ve climbed the
mountain and have celebrated our ascent from the bottom, only to realize the
climb is only half over. Now we must keep from falling off the path to the top
of the mountain.
cash seeks security in U.S.-based assets. All of the IRR offices in major
markets (populations greater than 3 million) report an increasing presence of
foreign investment capital. Major cities such as San Francisco, Los Angeles,
Boston, Philadelphia, Miami, Atlanta, New York, Washington, D.C., as well as
Houston, Dallas-Fort Worth, Chicago, and Salt Lake City are experiencing a
significant influx of direct foreign investment from China, Europe, and South
America. Trophy properties in almost all major American cities are being
competitively bid up with strong doses of foreign capital seeking refuge from
emerging market volatility. This leads to large portfolio transactions reaching
the investment thresholds of sovereign wealth funds and major institutional
no formal tracking mechanism for true foreign investment totals. Private equity
funds can be U.S.-based but internationally backed. The public real estate
investment trust market is agnostic as to where its investment capital
originates. While the lack of formal foreign tracking makes true foreign
inflows less transparent, IRR believes the amount of capital originating from
outside the U.S. is buoying the market.
and REIT capital will favor the major markets to the exclusion of tertiary
metros. This competition for major assets and portfolios will fuel investment
migration toward secondary metros with strong fundamentals, such as Denver;
Phoenix; San Antonio; Detroit; Charlotte, N.C.; Atlanta; Tampa, Fla.;
Indianapolis; and Seattle.
boomer retirement is knocking. IRR’s senior and healthcare specialty practice
group reports continued strong transaction activity and demand throughout the
U.S. Some of these fundamental improvements reflect a maturing industry model
and increased operating capabilities of the large platform operators. But this
market is affected by a core demographic shift for which this industry has been
waiting and planning for more than a decade. This asset class continues to grow
across all U.S. markets.
market investment in new development is a strong value play with fewer competitors
in addition to equally strong fundamentals, since boomers older than 70 years
will tend to migrate back to where their children live. The key metric here is
markets with high-wealth, high-value employment, since working children often
provide funding for extended healthcare, assisted living facilities, and
continuing care retirement communities.
extended life expectancy of the baby boomer generation favors Sun Belt markets
in 2014–15, never more so than following the brutal winter of 2013–14. The
Carolinas, Savannah and southern Georgia, Florida, Southern California,
Arizona, South Texas, and now Tennessee will be strong in-migration markets,
with fundamental improvements in second-home residential housing, and by
extension, retail investment to serve the growing population base. Continued
improvements in core housing values will favor migrating boomers with proper
equity leverage, facilitating relocation to warmer climates before the winter
pricing peak to trough is well over, and many markets report a return toward
prior peaks. Some of this asset appreciation is being driven by too much cheap
capital chasing real estate deals, but it is mostly big capital such as REITs,
private equity, and pension and sovereign wealth funds. Opportunities still
abound in the tertiary markets where the long tail of recovery will favor
coastal cities emerged from recession quickly, and the major U.S. markets were
aided by foreign and domestic investment capital that did little to assist
inland tertiary economies. Texas, Oklahoma, the Dakotas, western New York,
eastern Ohio, and Pennsylvania are the oil and gas extraction/production engine
of the U.S. Extraction and speculation pushed their local economies through
recession more quickly. Most if not all of the major coastal and
energy-producing regions are getting expensive again because observers can see
a clear path to wage, employment, and housing growth.
the balance of 2014 and early 2015 will be punctuated by new start-ups and
internal business growth as entrepreneurs and small businesses catch up. This
favors the inland tertiary markets.
deal flow will very likely continue an average upward trajectory, but pricing
will be more volatile. Major portfolio transactions and triple net lease
transactions will accelerate as investors will demand security and diversity in
exchange for higher asset pricing. The tertiary capitalization rates have been
compressed due to financing availability, but we expect to see strong
transaction activity at the local level in tertiary markets as local investment
boomers cash out in 2014–15.
estate value — and value growth — is a residual product of the local economy.
As economic activity expands, so will real estate values. Here are key trends
and markets to watch by property type.
Fannie Mae and Freddie Mac are mindful of our current conundrum. A lack of
available new multifamily product places upward pressure on rents, which in
turn affects the costs of subsidized housing. With more than five times as many
tenant vouchers compared to project-based Section 8 units under contract — both
totaling more than 300,000 units nationwide according to HUD.gov — most
projects are receiving some level of government-backed rental payment.
multifamily market activity has slowed in the larger institutional sector due
to compressing cap rates, as well as new construction and rehabilitation in
most markets. However, smaller assets under 50 units are now recovering and
provide the small investor a value-add opportunity. Markets to investigate
Detroit: Automotive industry is back
and producing under new cost structure.
Memphis, Tenn., Savannah, Ga., Virginia:
These hubs of emerging intermodal transport will drive rental demand during a
global shipping expansion.
Indianapolis: The CBD and suburban
north submarkets have a projected growth of 4,000 units, twice the reported
growth from 2013.
San Antonio: This strong university
market will drive employment as Sun Belt recruiting and Texas lifestyle
continue to attract employers.
Orlando to South Florida: Private
entity All Aboard Florida plans to run a high-speed train from Miami to
Orlando, with stops in Fort Lauderdale and West Palm Beach. This could have a
dramatic positive effect on Treasure Coast market if and when it nears
Chicago suburbs: The metro area
remains the corporate headquarters for many nonprofit organizations and the insurance
The office market has been essentially flat on real rent growth in most
domestic markets. Of all of the asset types, nine of the 63 primary, secondary,
and tertiary markets remained in recession as of the close of 2013, according
to IRR local reports. Despite this reality, the office investment class stands
alone as the primary asset class with sufficient scale for major one-off
investments. Sixteen of the top 25 commercial investment transactions in 2013
were office properties.
that are in the early stages of recovery will provide the best risk-adjusted
returns. Those in land-constrained markets with solid local fundamentals will
perform well. Markets with no clear path to breaking sub-15 percent vacancies
will produce pricing efficiencies. Markets to reconsider include:
Northern New Jersey: Asset prices in
New York City will drive collateral demand and core assets will be difficult to
replace given New Jersey’s current land pricing.
Tulsa, Okla.: The Texas energy boom
is migrating northward.
Atlanta: Recession effects aside,
this market has excellent core fundamentals.
Philadelphia: With Comcast as a major
driver, office rental rates are beginning to rise.
Richmond, Va.: This southern sister
to Washington, D.C., will track similar to Northern New Jersey.
Pittsburgh, western Pennsylvania:
Shale gas exploration is driving corporate office needs and collateral services
Detroit: Recessionary asset prices
were so low and employment growth will be robust in the coming 12 to 18 months.
Providence, R.I.: Employment growth
is slow, but downtown office conversions will reduce inventory.
Kansas City, Mo.: This steady market
delivers sub-15 percent vacancy with modest absorption and good fundamentals.
Boise, Idaho: Value plays abound as
new class A office is being well received.
Seattle: Below 10 percent vacancy and
anticipated strong absorption makes this a metro to watch.
No real estate class is more closely tied to economic recovery than the retail
sector. While facing other headwinds such as the loss of major shopping center
tenants, migration of retail users to pad sites, lack of new-format retailers,
and competing Internet sales, the next six months will see continued recovery
of gross retail sales as consumers increase household debt and feel more
financially secure with restructured housing payments and more retirement
equity. This extends to automotive and other durable goods. Continued housing
market stability remains the key metric in the fate of local retail growth.
Markets to watch include:
Miami, South Florida: Foreign capital
is a transfer payment on the back of a strong dollar as international residents
buy disposable items at a domestic discount.
Long Island, N.Y.: Wage growth in the
New York region will benefit this bedroom island of New York City.
Phoenix: Sun Belt migration and
retirement housing growth will transfer retirement wealth into this market and
the pricing is appropriate for long-term growth.
Naples, Southwest Florida: These
markets have nearly the same drivers as Phoenix with the added benefit of no
state income tax, which is driving in-migration.
Columbus, central Ohio: Demand for
new construction in prime locations is being prompted by unemployment rates
back to pre-recession levels.
Minneapolis/St. Paul: The Twin Cities
are in the retail recovery stage, which lends itself to stronger buying
opportunities, and major grocery anchors are responding.
Greater Boston area: Concentrated
regional wealth and improving wage growth and employment will drive demand.
Dallas: Toyota recently announced its
relocation to Plano, Texas, adding more than 1,300 jobs to the Dallas area.
Demand continues its shift away from core manufacturing to global supply chain
logistics. On the global import/export demand side, the major port cities are
driving industrial warehousing and logistics demand. Those key markets with the
most active ports include Los Angeles, Long Beach, and Oakland, Calif.;
Northern New Jersey; Savannah, Ga.; Norfolk, Va.; Houston; Tacoma, Wash.;
Charleston, S.C.; Miami-Ft. Lauderdale; Baltimore; Philadelphia; and
tertiary markets with a large manufacturing employer base are important to
services and retail business growth, and serve to generate new industrial space
demand. In the markets listed below, manufacturing components comprise 80 to 95
percent of all exports and 15 to 20 percent of local gross domestic product,
indicating external dollars are feeding these economies. These areas should
perform well in housing, wage growth, and general real estate demand. These
manufacturing markets are also part of the global export-supply side:
Charleston-Summerville, S.C.: Boeing
Aviation and related exports;
Cleveland: chemical manufacturing;
Ogden, Utah: aviation manufacturing;
Columbia, S.C.: transportation
Louisville-Jefferson County, Ky.: GE
appliance and Ford machinery;
Northeast Ohio: NEO exports
haverecovered quicker than U.S. exports; manufacturing gross product is
projected to grow about6 percent more than the U.S. average between now
Grand Rapids, Mich.: transportation
and machinery manufacturing; and
Greenville, S.C.: BMW, Michelin,
textiles, and research and development.
property types, strong activity in the tertiary markets will be aided by
stronger economic growth at the local level. We remain halfway through our
mountain-climbing expedition. Careful due diligence is required to ensure we
stay on the upward path.
M. Graziano, MAI, CRE, FRICS, is the senior managing director of the Miami/Palm
Beach offices, and Matthew S. Krauser, CRE, FRICS, is the senior director of
the Northern New Jersey office of Integra Realty Resources. For more
information, visit www.irr.com or blog.irr.com.