November 5, 2003—Real estate investors’ attitudes toward next year’s industry outlook range from “cautiously pessimistic” to “at best less sanguine,” according to Emerging Trends in Real Estate 2004, just released by the Urban Land Institute (ULI) and PricewaterhouseCoopers LLP. The annual real estate investment trends report, based on surveys and interviews with more than 350 of the industry’s leading authorities, finds 2004 to be widely regarded as a “transition” period, as markets move toward a weak recovery tempered by rising corporate outsourcing of jobs overseas, a lack of U.S. job generators, and fiscal woes at all levels of government.
The report says that so far, returns continue to belie weak market fundamentals, including high vacancy rates, falling rents, resurgent concessions, rising property taxes and higher operating expenses. However, if interest rates rise too quickly before job growth drives up leasing activity, property values could fall even as the economic recovery gathers steam, it says. “No one expects a sudden rebound—rents will be flat in most sectors, down more for office. Income returns carry the day, appreciation will be negligible and many office markets will experience value dips or worse,” the report says. “Retail returns will moderate, warehouses, apartments and hotels show slight improvements. Capital flows remain plentiful, but will diminish as an improving stock market draws attention away (from real estate.) Defaults and delinquencies will increase modestly, again office markets will be the most troubled.”
Emerging Trends in Real Estate(R), now in its 25th 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.
Emerging Trends notes that the jobless recovery is the interviewees’ leading concern. “Real estate markets need corporations to expand their U.S. workforces to fill empty office space, increase production and distribution benefiting warehouses, and step up business travel to lift hotels. Additional wage earners, cashing bigger paychecks, (will) rent more apartments and spend more in malls. That hasn’t been happening,” the report says.
Respondents also expressed unease over geopolitical risk and its ability to undermine a real estate rebound in America. While fears of terrorism have faded somewhat, some lasting impacts affecting building occupancy include a lingering reluctance of tenants to locate in the top floors of the tallest buildings, continued corporate dispersion, some increases in security and safety expenses, a growing concern over mall vulnerability, and curbed business travel.
Technology was cited as another factor affecting building occupancy. While advances have improved efficiency and productivity, such services as satellite systems, telecommunications improvements, secure Internet shopping, Internet travel and lodging reservations and just-in-time distribution systems are cutting the need for space, the report notes.
In its “markets to watch” category, only Washington, D.C. received unwavering endorsement from respondents as a still-promising investment market, followed by New York and the Southern California region from San Diego to Los Angeles. “After that—’ugh,'” says the report.
Other cities cited—either because their real estate markets are improving or because they are bargain bins—include Chicago, San Francisco, Seattle, Philadelphia, Phoenix, Houston, Denver, Atlanta and Dallas. Some respondents expressed growing interest in smaller second and third-tier cities, particularly those with state capitals or universities, such as Birmingham, Ala.; Tallahassee, Fla.; Columbia, S.C.; and Boise, Idaho. Concerns over sprawl-related issues, such as traffic congestion and inadequate infrastructure, dampened interest in larger second-tier cities such as Orlando, Fla., Nashville, Tenn., and Charlotte, N.C.
Other Emerging Trends highlights:
- Industrial—Strength: The warehouse sector typically recovers earlier in the economic cycle, rather than lag like the office sector. Weakness: More efficient tracking systems cuts storage requirements and demand for space. Inadequate parking and access hurt many industrial parks. Best bet: Large regional distribution centers near airports, rail lines and ports. Outlook: As inventories get tapped out (over next few years), manufacturing and distribution will rise, benefiting warehouses. Opportunists will find bargains in the research and development sector.
- Office—Strength: Prime, well-leased buildings in 24-hour cities—mainly New York and Washington—continue to attract buyers. Weakness: In most other markets, office market supply/demand fundamentals are extremely weak and will continue until white-collar job growth improves. Suburban office markets should “prepare for a free fall.” Best bet: Hold or buy properties with lease rosters with minimal rollover risk in the next five to seven years. Outlook: For 2004, revenues erode, values decline. Concession packages will keep real rents from stabilizing until 2005, and any income growth may be delayed until 2006 or 2007.
- Hotels—Strength: Capital remains abundant, holding prices steady. In general, owners are well capitalized and can hold investments through the downturn. Weakness: Internet discounts and a decline in business travel are hampering operators’ pricing power. Staffing layoffs help maintain some profitability, but guest service suffers. Best bet: Focus on full-service hotels in strong 24-hour markets. Outlook: There is little chance for substantial improvement in 2004, due to 1) continued security concerns related to terrorism; and 2) corporate spending cuts.
For more information, contact The Urban Land Institute as well as PricewaterhouseCoopers.
