• Share
  • Email
  • Embed
  • Like
  • Save
  • Private Content
12 Trends For 2012 Final Locked[2]
 

12 Trends For 2012 Final Locked[2]

on

  • 263 views

Excellent report from CBRE\'s Econometric Advisors on the 12 Corporate Real Estate Trends for 2012 - Enjoy!

Excellent report from CBRE\'s Econometric Advisors on the 12 Corporate Real Estate Trends for 2012 - Enjoy!

Statistics

Views

Total Views
263
Views on SlideShare
261
Embed Views
2

Actions

Likes
0
Downloads
1
Comments
0

1 Embed 2

http://www.linkedin.com 2

Accessibility

Categories

Upload Details

Uploaded via as Adobe PDF

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

    12 Trends For 2012 Final Locked[2] 12 Trends For 2012 Final Locked[2] Document Transcript

    • CBRE Econometric Advisors SPECIAL REPORT12 Trends for 2012 January 2012
    • TABLE OF CONTENTS Special Report: 12 Trends for 2012 TREND #1 EMPLOYMENT GROWTH WILL CONTINUE TO MUDDLE THROUGH PAGE 3 Balance Sheets Prevent Level of Growth Needed TREND #2 CAPITAL FLOWING, BUT ONLY TO THE RIGHT OPPORTUNITIES PAGE 4 Global Picture Shows Eastern European Growth TREND #3 HOUSING SEARCHES FOR BALANCE PAGE 6 Rising Rents Help to Stabilize Home Prices TREND #4 SUBURBAN OFFICE WILL CONTINUE TO TAKE PART IN THE RECOVERY PAGE 8 Busting the Myths Suggesting the Death of Suburban Office TREND #5 SHORTAGES IN LARGE WAREHOUSE SPACE WILL ACCELERATE PAGE 10 Large Warehouses Recovering Faster than Overall Industrial TREND #6 HOTEL ROOM DEMAND GROWTH WILL SLOW PAGE 12 Overseas Slowdown will Contribute TREND #7 DEBT MARKET DISTRESS MOVES PAST PEAKS BUT REMAIN HIGH PAGE 13 A Widening Window of Investment Opportunity? TREND #8 CONSTRUCTION MAY RETURN SOONER THAN YOU THINK PAGE 15 Single Tenant and Delayed Projects Bring Back New Building TREND #9 RETAIL RENTS FINALLY SEE BOTTOM PAGE 18 Lagging Behind Other Property Types, Last Pieces Fall in Place TREND #10 MOVEMENT FROM TRUCKS TO TRAINS WILL BE INCREMENTAL PAGE 19 Rise of Rail Inevitable but Slow TREND #11 IN SPITE OF CAPITAL MARKETS VOLATILITY, FINANCE JOB CUTS TO END PAGE 21 BY MID-YEAR 2012 Many Finance Sub-categories Have Seen Losses Level Off TREND #12 CAP RATE COMPRESSION WILL END PAGE 23 Cap Rates Flat or Worse in the Next Two Years January 2012 Page 2 © 2012, CBRE, Inc.2
    • TREND #1 Special Report: 12 Trends for 2012 answer to the lack of professional surprise for forecastsEMPLOYMENT GROWTH WILL of moderate employment growth in 2012. Output, asCONTINUE TO MUDDLE THROUGH measured by Gross Domestic Product, is our best measure ofBalance Sheets Prevent Level of Growth demand for work, but increases in output are not sufficient toNeeded generate jobs because work can sometimes be accomplished by stretching existing resources, rather than employing new2012 will mark the third consecutive year that employment ones. At no time has this been truer than the recent cycle.fails to generate much growth. That we begin this period witha high level of unemployment makes it all the more painful, Economists think about productivity both as an importantand that the upcoming year will again make little progress long-term factor for the economy and also as it relates toin reducing unemployment is frustrating for everyone. cyclical employment growth. Over longer periods, higherAvailability of labor generally encourages businesses to hire, productivity growth is one of the best things an economy canso unemployment remaining high is surprising; yet what produce. It is the foundation of sustainable wage growthshould be surprising among economists and business leaders (or at least an expanding pie). Within a cycle, however,is widely accepted. It is worth examining why there has been productivity is not always as welcome, as higher productivityacceptance of high unemployment in this business cycle. means that businesses can expand without hiring. In recent cycles, productivity has been highest as output has started toThe connection between output and employment is a factor rebound, with companies first finding efficiencies that wouldin this acceptance. That the difference between output allow their current workers to accomplish more and only latergrowth and employment growth is productivity, is effectively resorting to hiring as demand continues to expand. In thea mathematical identity. As such, productivity is part of the early stages of this expansion, year-over-year productivity growth was even higher than usual.Productivity Now More Likely to Precede Job Growth Employment YoY Growth (%) GDP Productivity 10 8 6 4 2 0 -2 -4 -6 1984Q1 1985Q1 1986Q1 1987Q1 1988Q1 1989Q1 1990Q1 1991Q1 1992Q1 1993Q1 1994Q1 1995Q1 1996Q1 1997Q1 1998Q1 1999Q1 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 Source: CBRE Econometric Advisors, BLSIn determining where productivity (and therefore employment) productivity growth. The 1980s and the period from 2004is going in the next year or two, judgments are made. First, to 2008 were marked by low productivity growth, while thewhat is the level of productivity growth we should expect in 1990 tech boom led to growth rates often above 3%.this expansion, and second, what cyclical effects can weexpect next year? The former question is interesting because The slowdown in GDP in 2011—averaging 1.2% in the firstthe last three expansions have seen such different levels of three quarters—affects our views on the cycle of productivity January 2012 Page 3 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 in 2012. Such slowdowns are indeed a setback for the years. Net exports were previously a hope for an increase employment recovery, quite literally. In contrast to similar in GDP but the European crisis closed off this avenue in , stages in the past two cycles, in the past year productivity was 2011. Government is the last remaining category and one brought down more by slowing output than by improving need look no farther than the September debt ceiling crisis to employment growth. This puts us back to where we were become dispirited about any assistance being offered there. some time ago; so, while it won’t be at the magnitude of What has not been discussed enough is how the rise of the 2009, we expect to see a period of productivity increase filibuster suggests that the future will insure no assistance as before we see hiring pick up. As a result, even as we see well, regardless of the results of this November’s elections. GDP improving in 2012 over 2011, it will take much of the year for this to translate into significant new hiring. Until these conditions change—say, after debt is better paid down or housing has begun its recovery—it is hard to see Looking at these factors from another angle, output growth enough aggregate demand coming through to change the needs to be exceptionally high to restore the unemployment employment situation in the way we all would like. This situation to normal. To take some round numbers: if we are explains why there are very few optimists expecting anything around 9% unemployment today, and 5% is more in keeping more than “muddling through” over the next few years. with full employment, we need 2% employment growth On the brighter side, trends have been seeing gradual above the annual labor force growth of around 1% just to improvement in all the underlying constraints mentioned reduce the unemployment growth within two years. But in in the above paragraph, so expectations for a return to order to obtain the 3% employment growth target we just recession remain rare among economists. From this arrived upon, we need GDP growth to be 2 percentage points standpoint there is contentment with “muddling through”, faster, to overcome the expected increases in productivity. as it is better than the next most likely alternative. In short, growth rates need to be routinely 4% to 5% over many quarters to see the type of job recovery that has been more typical in the post-war era. TREND #2 So while there is some relief when GDP growth makes it CAPITAL IS FLOWING, BUT ONLY TO above 2%, this is more about the economy having what it THE RIGHT OPPORTUNITIES takes to avoid dipping back into recession, than it is about Global Picture Shows Eastern European the economy improving in any way that the average citizen Growth will appreciate. Indeed, recent job gains, retail sales, and industrial production have increased enough to make us We will look back on 2011, fondly or not, as a year comfortable that a recession is not imminent. Unfortunately, full of economic and financial shocks that reverberated we also believe that output growth will stay in the 2% range throughout the global economy. Volatile global financial for much of 2012. markets, solvency concerns throughout the European Union, and the combination of sluggish U.S. job growth The reasoning has to do with to the differences between and political gridlock in America’s capital led to a drop in more typical recessions and what some have called the optimism following a number of positive indicators and “balance sheet recession” we are seeing today. The distinct reports that characterized the global economic recovery feature of the recent recession is the high level of debt and in early 2011. This uncertainty has dampened both the the need across much of the economy to deleverage from already-weak recovery in advanced economies and the those high levels. If we are to achieve 5% GDP growth, a more robust expansion in emerging markets. Meanwhile, good anchor would be for consumers to spend at a similar Western Europe is flirting with yet another recession. pace. This has happened in the past as consumers have made up for delayed purchases, but the necessity to pay And while the current high level of uncertainty puts any down debts has placed a limit on how fast consumers are projection at risk, we expect the pattern of a two-speed willing to increase spending. We could turn to investment, global economic recovery, with pockets of economic but the overhang of housing means that the major category and commercial real estate growth in select regions and of residential investment will be moribund for a few more markets, to continue as we head into 2012. January 2012 Page 4 © 2012, CBRE, Inc.4
    • The Multi-Speed Economic Recovery Continues Special Report: 12 Trends for 2012 commercial property prices remain below their pre- Western Europe United States downturn peaks, exposing investors to high refinancing Real GDP, YoY % Change Asia Pacific World risks, which may increase property sales as investors seek 10 to raise capital. 8 6 4 Can We Find Growth Anywhere? Europe presents a prime case of how demand drivers for 2 real estate exist even in the face of economic uncertainty. 0 -2 The early days of the economic recovery were marked by -4 strong investor interest in prime assets in prime markets, -6 with trophy office buildings in major markets such as London -8 and Paris experiencing great interest and bidding activity. 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2005Q1 Germany and France—traditionally real estate investment magnets, both of which have so far outperformed the overall Eurozone in terms of economic growth—attractedSource: IHS Global Insight as of Q3 2011. a great deal of capital targeting their commercial property sectors. But with the economic recovery waning as a resultThe Investment Market of sovereign debt concerns, investors are searching forDespite a backdrop of deteriorating European economic properties beyond traditional hotspots. This is evidencedand financial market indicators, property investment held by recent acceleration in cross-border activity targetingup well in 2011. Globally, commercial property transactions the commercial property sector. According to Real Capital(excluding land sales) in the first three quarters of 2010 Analytics, in the third quarter of 2011, the percentage ofincreased by 40.3% compared to the same time period trading volume involving cross-border capital reached itsduring the previous year. Regionally, growth was strongest highest point in three years. And while the usual marketsin the Americas (+71.6%) followed by EMEA (+31.2%) and in U.S., France, Germany and the UK continue to attractAsia Pacific (+16.8%). capital, yields in these markets have fallen and cross-border investors are shifting to other areas of Europe despiteGlobal Transaction Volume Continues to Recover concerns over the future of the European Union. Investors Asia PacificQuarterly Transaction Volume by Region, billions EMEA have begun to look at other areas, such as Poland, Russia Americas $140 and Turkey. Recent surveys show a marked increase in cross- $120 border transactions in Central Eastern European markets, where governments are not straddled with the overarching $100 debt issues of many of their larger neighbors. $80 $60 The increased investor interest in Central and Eastern $40 Europe reflects growth in the demand for certain classes of $20 commercial property. Of the fifteen global office markets with the strongest growth in occupied office stock over 0 the past year, nine are located in the region. Warsaw, for 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q1 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 example, was the only EU nation to avoid a recession inSource: Real Capital Analytics 2009, and experienced a 6.5% increase in occupied officeRecent surveys point to continued investment in commercial space during the past four quarters. Other markets in theproperty—transactions remain below their pre-recession region recording similarly strong performance includepeaks, but volumes continued to recover in 2011. Moscow, Kyiv, St. Petersburg, and Prague.Transaction volume is expected to remain steady in 2012,even in Europe; according to the European Central Bank,approximately a third of outstanding commercial propertymortgages are expected to mature by 2013. Prevailing January 2012 Page 5 © 2012, CBRE, Inc.
    • Office Hotspots in 2011 TREND #3 Special Report: 12 Trends for 2012 Growth in Occupied HOUSING SEARCHES FOR BALANCE Market Office Stock Rising Rents Help to Stabilize Home (Q3 2010 - Q3 2011) Prices Abu Dhabi 25.8% Guangzhou 19.2% Can housing finally find a bottom in 2012? There are Shanghai 15.2% some good reasons to think that it can, as long as one Beijing 14.5% looks at the whole market, rather than just the for-sale segment. Total household growth and new construction Kyiv 12.6% should strengthen as the economy adds more jobs and Moscow 11.7% the unemployment rate drops. It is important to see the Bucharest 11.1% two sides of this trend, however—their interaction is what Mexico City 10.5% ultimately drives the housing recovery. St. Petersburg 9.9% Owner-occupied units account for about two thirds of Sofia 9.5% the nation’s housing demand. Given the still-high rate of Belgrade 8.8% foreclosures and their negative impact on home prices and Warsaw 6.5% sales, it is likely that owner demand will continue to struggle, San Jose 4.5% although perhaps not as much as it did last year. At the Bratislava 5.4% same time, rental demand is expanding at a near-record pace that is well ahead of supply. As a result, vacancy is Prague 4.6% falling and rents are rising in every region of the country—a Source: CBRE Research key building block for an eventual recovery in home prices. These markets are enjoying demand for office space from international as well as domestic occupiers. Healthier The housing market is being shaped by many countervailing government balance sheets, relatively low labor costs, forces. The costs of buying a home now are record-low and high rates of education have attracted a number of relative to both household incomes and rents, which international companies, both from continental Europe makes pursuing homeownership today an opportunity of and beyond. a generation. At some point, this high and rising housing affordability should unleash pent-up demand, leading to Summary rising sales and prices. The chart below illustrates this, The outlook for the coming year is very dependent on displaying the ratio of monthly principal and interest governmental policy responses—which makes the level of payments on a median-priced home, to rent. This ratio is uncertainty high. Policy responses have been inadequate computed historically using the all-transaction home price and slow across the globe, and this shows no signs of and apartment rent index. In 2011, for example, with a changing. Commercial property data, however, point to a 4.9% interest rate, the cost of owning a $250,000 home number of markets that have experienced positive growth in purchased with a 20% down payment comes to about occupier and investment demand—even in Europe—despite $1,100 a month—which is very close to the current national the uncertainty. That economic momentum remains uneven average rent. It turns out that the current ratio is not only will continue to drive investment activity both within and more than 20% below the historical average; it is also at across borders. a record low over this period. January 2012 Page 6 © 2012, CBRE, Inc.6
    • Housing Affordability is at a Record High Special Report: 12 Trends for 2012 the second half of the year. At the same time, this impactRation of monthly principal and interest to rent, 2011Q3=1 should be less negative than in 2011, if the economy does1.7 show steady improvement in the first half and the so-called1.6 “strategic defaults” do not intensify. Under this more1.5 optimistic scenario, almost 0.5 million households will still1.4 lose homes, which would push the homeownership rate1.3 2006-2011 average down by another 30-50 basis points. As a result, prices1.2 will still decline, but probably by only 1-2%, as compared1.1 to the 3-4% in 2011, when the losses to owner demand1.0 were also more severe.0.9 The U.S. Homeownership Rate is Likely to Continue 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Declining in 2012 Homeownership RateSources: Federal Reserve, FHFA, MPF Research, CBRE Econometric Advisors. Renter Households Homeownership Rate, % Renter Households, Millions 71 42Whether it does unleash demand ultimately depends on 70 40households view of homeownership in this fragile market. 69 38This view is being shaped by three factors. First, with 68 36 67 34hundreds of thousands of homes entering foreclosure 66 32every month, some buyers expect further declines in home 65 30prices, or are uncertain about the fair market value of 64 28 63 26homes. Second, the labor market is still too weak to boost 62 24confidence much and with the unemployment rate high, it 61 22takes a person longer to find a job today than it did in the 60 20 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010past. In such an environment, households have to be ableto move quickly to where jobs are. Being that it takes time Sources: Bureau of the Census (Housing Vacancy Survey), CBRE Econometric Advisorsto sell and buy a house, mobility and homeownership are atodds with one another. A third factor is buyers expectations The silver lining to this is the accompanying expansion in thefor building equity while owning homes. With property taxes number of renter households: combined with demographicand maintenance costs high and home price appreciation growth, the shift from owning to renting should yield overyet to resume, home ownership does not yet look like the 0.7 million new renters. As a result, growth in rentalsure investment it used to be. Another key impediment to demand will exceed supply next year, although not byhome ownership is that higher mortgage down payment as much as one might expect. While new completionsrequirements, combined with depleted household savings, intended for rent will be low by historical standards—nearare making it much harder for households to qualify for 0.2 million units—rental stock will also add over 0.4loans. As long as unemployment remains high, rebuilding million units through conversions from owner-occupiedcredit will be a slow process for most households, and and vacant for-sale units. More than 4 million unitswill be particularly challenging for those who are near have been converted to rentals since 2004, significantlyretirement. constraining improvement in the rental vacancy rate—and conversions will remain a significant headwind, especially ifForeclosures remain a major drag on housing appreciation, owner demand falls. Considering this, rent growth shouldand progress in stemming them has been slow. While rates approach its long-term average of about 3%, but a muchof foreclosure starts and completions have declined from stronger inflation will prove challenging.the peak, the share of mortgages in foreclosure remainsnear its record high of 4.5%. Distress is likely to continue Home prices remain under pressure from a majorto affect home sales and prices during 2012’s spring imbalance brought about by the housing boom and bustand summer home-buying season, considering that the of the last decade: there are about 2.5 million morelabor market is not expected to gain much traction until vacant units than there were prior to the correction. Of this January 2012 Page 7 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 inventory, only 0.5 million units are on the market, however, on their way to gradually becoming a thing of the past, as and this has a direct impact on prices. Current household individuals are choosing more central, urban locations with growth is 0.7 million per year (half the historical average) easy access to mass transit, restaurants, cultural activities and with home demolitions of 0.3 million, new demand and their places of work. Such a trend would not only have must be close to a million units and well ahead of the 0.6 a major impact on residential real estate, but it would also million in new completions. Household growth is a largely present a significant challenge to the sustainability of the a function of labor market conditions, and with a stronger nation’s suburban office markets. pace of recovery, virtually all of the excess supply for rent and for sale could be absorbed by the end of next year. The The problem with the argument for the de-suburbanization negative effect that the glut of vacant homes on the market (or re-urbanization) of America to this point is that it is less is having on prices would subside as a result. theory than it is a hypothesis that has yet to be fully tested. The story of a population base shifting from suburban to It is much harder to foresee how many of the homes now in city locations sounds plausible, but the lack of empirical the “shadow” inventory might be put up for sale next year. evidence thus far makes it hard to defend. While data Historically, the share of these units entering the market has from the most recent decennial Census show that cities are increased when buyer demand and prices were strong— indeed growing, they also show that they are not growing which will not be the case in the near term. At the same any faster in most cases than their suburban counterparts. time, many of these units are non-primary residences, so it is possible that more owners will decide to strategically None of this matters, however. If a story gains enough default on their mortgages this time around—especially in traction, it can take on a life of its own—even without the areas were home prices are still down by more than 20%. research or data to back up the argument. For their part, Investors’ views of the market will play a major role in commercial real estate investors appear to have bought into shaping their decisions. the argument for the renaissance of center cities, and are adopting strategies to divest themselves of suburban assets. In summary, U.S. housing should see a slight improvement Transaction data have shown that over the past year an in price trends along with moderate rent growth in 2012, increasing share of deals has been based in downtowns, preparing ground for a more sustained recovery later. as investors view these assets to be more liquid, and are Rising rents can help to stabilize home prices but any willing to buy yields below 5% in markets like New York. real progress can only take place when households have trust and confidence in the economy—including a more But investor behavior does not fully support the argument robust job market and an expectation of building home that the suburban office market is dead as much as it equity—and enough resources to qualify for mortgages. reveals something about investor appetite for risk at this Foreclosures remain the major wild card and as such the stage in the recovery. Investment activity has been focused outlook will depend on how quickly they are being resolved. largely on core assets in high-profile locations in markets In this regard, 2012 can be viewed as a transition year for like New York, Boston and San Francisco; the reasoning the U.S. housing market. is that prime downtown locations offer a buffer against downside risk by way of increased liquidity, when compared with suburban locations. This is nothing new, however, as investment typically picks up for well-located core assets TREND #4 first during a recovery, then spreads beyond downtowns and SUBURBAN OFFICE WILL CONTINUE into suburban locations as investors grow more willing to TO TAKE PART IN THE RECOVERY take on more risk to expand their portfolios. Busting the Myths that Suggest the Death of Suburban Office Another way to look at this argument is through property fundamentals. If a secular shift is occurring away from There has been no shortage of discussion lately about the suburbs and toward downtowns, surely this should manifest death of the suburbs as an American institution. Some itself in the property data. We can start by looking at metropolitan population pundits suggest that suburbs are demand for office space, which should reveal location January 2012 Page 8 © 2012, CBRE, Inc.8
    • Special Report: 12 Trends for 2012preferences for businesses. Historically, net absorption in the office market recovery simply does not hold up acrossabsolute terms has favored suburban markets, but in recent the board. In fact, we see a picture that suggests that thedecades this has largely been a function of the relative strength of the office market recovery is more focused onsize of the suburban office market, which today makes up submarkets outside of the nation’s CBDs. In itself this isroughly two-thirds of the nation’s office market. Looking at not all that surprising; historically, demand for suburbanthe net absorption rate, which accounts for the relative size office space has outpaced that of downtown locations. Whatof the market, allows for a more fair comparison. might be surprising at this point, then, is that demand in downtown office markets has managed to keep pace withWhen these series are graphed, we can see the relative the broader trend.demand trends for downtown and suburban office space.What we see is that the recession’s demand fallout was But this also highlights an important distinction betweenfar more severe for downtowns, and that they still have a submarkets and markets. When we talk about downtowngreat deal of ground to make up. Moreover, there is not versus suburban markets, we are comparing manya discernible difference between downtown and suburban different and diverse submarkets within cities and broaderoffice demand in the period since the recovery began, metropolitan areas, respectively. It is entirely possible fordespite the perception that most of the improvement has pockets of strength to lead to more robust results for abeen in core locations. particular market. In New York’s downtown submarkets, for example, this can be seen by looking at Sixth/Park AvenueOne might even argue that suburban office has outperformed and perhaps World Financial Center (WFC), where vacancydowntown, in terms of demand. With respect to core rates are well below market average and are outperformingperformance in downtowns, just a handful of markets are their suburban counterparts. While these may be attractiveshowing solid performance. New York is perhaps the best submarkets, investors will also have to pay a price for suchand largest example of this type of improvement, but it prime locations, in the way of lower yields.also skews the results. By itself, New York has accountedfor nearly half of all downtown demand year-to-date, and Another argument for downtown office investment has to doa comparison of downtown versus suburban office without with rent and vacancy. True, vacancy rates in the suburbsNew York produces a very different result, and a different tend to run higher than downtown markets, and tighterview of relative performance. leasing markets support rent growth, which drives income and returns. But vacancy rates don’t in themselves dictateAre Suburbs Lagging or Leading in the Recovery? rent growth—it’s the market or submarket equilibrium Downtown vacancy rate level that is important. To that point, bothOccupied Stock, YoY % Chg. Suburban Downtown ex-New York downtown and suburban vacancy remains elevated and 4 above what would support rent growth on par with broader 3 inflationary measures. But this is changing and the rent 2 cycle has shifted from correction to recovery. 1 Downtown office rents have historically grown faster during 0 upswings, which can attract investors when the market is -1 on the way up—but they fall faster during corrections. -2 Because downtown rent cycles see such wide oscillations, -3 average growth between downtown and suburban office 2007.1 2007.2 2007.3 2007.4 2008.1 2008.2 2008.3 2008.4 2009.1 2009.2 2009.3 2009.4 2010.1 2010.2 2010.3 2010.4 2011.1 2011.2 2011.3 2011.4 2012.1 2012.2 2012.3 2012.4 markets is statistically difficult to distinguish over the pastSource: CBRE Econometric Advisors. 20 years—something that will not change anytime soon.Leasing decisions in markets like New York are usually While rent growth in downtowns has picked up faster thanreflective of corporate conditions and planning rather than in the suburbs, much of this can be attributed to a veryoutright business formation and job growth. Without this, small core of markets—and submarkets. Once landlordsthe picture of strong downtowns emerging and leading regain a measure of pricing power in downtown markets January 2012 Page 9 © 2012, CBRE, Inc.
    • Little Difference in Rent Growth Special Report: 12 Trends for 2012 deal of traction in the press without having a good deal Downtown TW Rent Index, YoY % Chg. Suburban of supporting data. For their part, investors should be Downtown Ex-New York 20 conscious of whether their decisions are based on headlines 15 and perceptions of new urban theory, and they should look 10 to how much empirical evidence exists to support their 5 perceptions. 0 -5 -10 -15 TREND #5 -20 SHORTAGES IN LARGE WAREHOUSE SPACE WILL ACCELERATE 2000.1 2000.3 2001.1 2001.3 2002.1 2002.3 2003.1 2003.3 2004.1 2004.3 2005.1 2005.3 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 2012.1 2012.3 Source: CBRE Econometric Advisors. Large Warehouses Recovering Faster Than Overall Industrial they tend to move more aggressively in order to maximize operating income during the upswing. Again, excluding It comes as no shock to property investors to hear that the New York gives us a much different perspective that shows recent recession ravaged the industrial sector. The sour that rent growth across most markets is roughly the same. economy, falling trade and inventories, and plunging Also, those investors who bought at the height of the market industrial production conspired to push the availability in downtown locations, thinking they were hedging their rate in the nation’s industrial sector to a record high. With bets, are now facing the threat of diminished cash flows the recession now over and many of the sectors’ primary as those leases are starting to roll. This is something worth demand drivers recovering nicely, industrial property has considering even in a market like New York, or perhaps San reported healthy demand every quarter for the past year. Francisco, where rents dropped in excess of 20%, peak to Looking deeper, however, it becomes clear that 2011 will trough, before beginning to rebound. Building owners in go down as a year of consolidating and upgrading by these markets will need every bit of that accelerated growth occupiers. to cover leases signed at the top of the market. Lots of available space combined with very low rent The office market continues to face a lengthy recovery levels has provided great opportunities for occupiers to and after a transition in 2011, next year will be another consolidate space or upgrade to higher-quality space. important step on the road back. The talk about the Consolidation is being reported in markets all over the downtown renaissance and suburban demise will likely country, with firms consolidating multiple smaller facilities continue, but you won’t hear it from us—at least not as part into fewer larger ones in a constant drive to reduce of an argument on permanent trends. Sure, downtown core Demand for Large Buildings Held Up Comparatively assets will continue to trade at a premium and rent growth Well During the Recession will likely outpace its suburban counterpart; that won’t be Small by much, however, and performance will be mixed, with the Absorption Rate Big best downtown submarkets leading improvements. There is 1.2 1.0 also little evidence that demand for office space in suburban 0.8 business parks is likely to evaporate any time soon. 0.6 0.4 The point in all of this is not that 2012 will be the year of 0.2 the suburbs or that investors should alter their investment 0 -0.2 strategies and divest themselves of downtown assets. -0.4 Investors like downtowns for a number of valid reasons, -0.6 including longer lease length, access to capital for liquidity -0.8 2000.1 2000.3 2001.1 2001.3 2002.1 2002.3 2003.1 2003.3 2004.1 2004.3 2005.1 2005.3 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 and potential for NOI growth in an up market. Rather, our aim is to shed light on a debate that has gained a great Source: CBRE Econometric Advisors. January 2012 Page 10 © 2012, CBRE, Inc.10
    • Special Report: 12 Trends for 2012expenses. This has led to above-average demand for larger rate of large buildings. The large building availability rate,facilities during the past year. For almost the entire recession which historically has been several percentage points belowand specifically for the last four quarters, the nation’s largest the overall sector, rose faster and sooner than that of allindustrial facilities—those of more than 500,000 sf—have buildings early in the recession, until it was essentially inbeen experiencing positive demand. line with the overall industrial sector. The recession caused new construction to pull back dramatically for all types ofThe recession officially started during the fourth quarter of buildings, even as demand for large buildings remained2007, and large buildings have reported comparatively positive during most quarters. This allowed the segment’srobust demand since the beginning, with average quarterly availability rate to stabilize sooner, and to drop faster, thandemand of nearly 4 msf, compared to -5.9 msf for smaller that of the overall industrial sector.facilities. For the past year, large buildings have beenresponsible for 18% of all the absorption in the nation’s Although nationally the demand for large buildings hasindustrial sector, yet large buildings account for only certainly outpaced demand for small buildings, availability13% of the nation’s stock of industrial space. This strong rates are comparable, due to relatively high large buildingabsorption has allowed the large building segment to construction. In some markets the difference is far greater,see its availability rate fall 100 bps since the peak of the however, and shortages are being reported in places.recession, to 12.5%; the country’s smaller buildings have Austin, for example—a smaller industrial market whereseen a decrease of 90 bps over the same period, to 14%. larger buildings comprise just under 10% of industrialWhile those two figures are not dramatically different, the space—has no available space in its largest buildings.availability decrease among large buildings is impressive Houston and Riverside, two of the largest markets we cover,when you consider that large buildings also accounted for with great infrastructure and transportation networks, are44% of all construction during the period—a far greater both reporting availability rates below 5% among theirshare than we’ve seen at any point in our history. But though largest buildings, versus double-digit rates for the marketthe share of total construction is high, absolute levels of new as a whole.construction remain very low, currently running at about half Shortages Now Bring Reported in Some Marketsof what is being demanded. Over the past four quarters, Current Availability Rates (%)the construction rate for large buildings has been 0.16%, Market Large Buildings Market Levelwhile the absorption rate has been 0.39%. Austin 0.0 14.4 Availability Rates Stabilized Sooner for Large Houston 4.5 10.2 Buildings Riverside 4.8 12.1 Small Availability Rate, % Big Minneapolis 7.0 11.4 16 Denver 8.2 12.7 14 Chicago 12.5 15.4 12 Atlanta 15.1 18.1 10 Nation 12.5 13.7 8 Source: CBRE Econometric Advisors. 6 4 As the economy continues to recover and the industrial recovery spreads, 2012 will see more of these spot shortages 2 2000.1 2000.3 2001.1 2001.3 2002.1 2002.3 2003.1 2003.3 2004.1 2004.3 2005.1 2005.3 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 show up, as rents still are too low to justify substantial new construction. In Atlanta, where the recovery has been slower Source: CBRE Econometric Advisors. than the nation’s, and where there currently isn’t a shortage of any type or size of space, the large building segment isRecord-high construction of large buildings during the early now showing signs of strength. The large building segmentstages of the recession, combined with weakening demand in Atlanta has seen availability rates fall 330 bps from theiras the economy soured, led to a rapid rise in the availability recessionary peaks, compared to a decline of 140 bps for January 2012 Page 11 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 the market overall. Similar trends are starting to show in factor in boosting the demand recovery in its early phase Dallas, where a massive large-building boom that lasted was that room rates fell to historically low rates during through the early parts of the recession pushed availability the downturn; ADRs remaining low well beyond the start rates of large buildings above 22%, while the market as a of the demand recovery has only compounded the effect. whole registered 17.1%. Since the recession has ended, Though the hotel recovery has remained resilient, growth however, the availability rate has fallen much faster for the has diminished a bit and factors will arise in the coming large building segment, with its current availability rate now quarters to diminish growth even further. comparable to the market’s overall 15.3% rate. Robust Demand Recovery Underway Demand Growth (R) Looking to 2012, as the economy continues to steadily 4 Qtr. Moving Avg. Demand recover and hopefully even to accelerate, it is clear that we SF x 1000 Demand Growth, YoY (%) will start to see increased spot shortages—particularly of 1500 15 the largest industrial assets. The economy-of-scale benefits 1400 10 expected from building super-large assets have historically 1300 been constrained by the technological difficulties of heating 5 1200 and cooling those assets, such that taking advantage of 0 their immense size in a cost effective way has been difficult. 1100 -5 However, recent technological improvements have allowed 1000 for more of these buildings to be built and for occupiers to 900 -10 benefit from their scale. Larger buildings that are now cost 800 -15 effective to run and manage will lead to more consolidation 1988.1 1989.1 1990.1 1991.1 1992.1 1993.1 1994.1 1995.1 1996.1 1997.1 1998.1 1999.1 2000.1 2001.1 2002.1 2003.1 2004.1 2005.1 2006.1 2007.1 2008.1 2009.1 2010.1 2011.1 2012.1 2013.1 2014.1 among firms that currently use several smaller facilities. Source: CBRE Econometric Advisors. And with supply chains increasingly dependent on cheap and reliable transportation systems, recent rail investments also have the potential to encourage firms to consolidate The rapid recovery in demand for hotel rooms, which multiple facilities into a single one located near a strong began as early as mid-2009, was historic. Reaching intermodal network, reducing the high costs associated growth rates of 10% on a year-over-year basis, the rate with truck shipments. With minimal new construction of rebound well surpassed the recovery that followed the and fewer buildings available to be leased up, in 2012 2001 recession, despite the fact that the demand declines this consolidating trend will have only shortages of large during this recession were slightly less severe than in 2001. buildings to constrain it. Since that historic 10% growth, the demand growth rate has decelerated consistently and currently reads around 5%. The pattern is similar to what we witnessed following the demand spike in 2004, when the pace of demand growth TREND #6 fell consistently until 2006, even declining for a couple of HOTEL ROOM DEMAND GROWTH quarters before stabilizing at around 0.5% in 2007. The WILL SLOW more recent sharp improvement in hotel room demand Overseas Slowdown will Contribute helped us achieve expansion by the end of 2010. Demand growth will likely stabilize in the coming quarters. This hotel recovery has been one for the record books. After a near-halting of business and leisure travel during During the recent hotel recovery, the boost in demand has the recession brought a significant decline in demand for come from international, rather than domestic, travelers. rooms in 2008 and 2009, the hotel industry has witnessed Just as demand growth was reaching 10%, international dramatic demand improvement since the economy has tourism growth was achieving nearly the same growth begun to show signs of recovery. A rapid increase in figures, while domestic travel remained much lower. international tourism helped to fuel the demand recovery in International travelers were most likely taking advantage the U.S., but as global unbalance has plagued travelers in of the low room rates, but rates have risen since then recent months, international tourism has dropped. Another and the global crisis is creating international tourism January 2012 Page 12 © 2012, CBRE, Inc.12
    • Special Report: 12 Trends for 2012uncertainties, which will most likely have a negative effect hotel owners slashed room rates in order to keep demandon hotel demand growth in coming quarters, particularly from sliding even further into the red. This has translatedas the UK, Germany and France are three of the top ten into rates that are still 8% below their previous peak, eventourist generating countries for the U.S., in terms of the following several quarters of growth. Hoteliers were quicknumber of arrivals, according to the Office of Travel and to start increasing rates again soon after there was proofTourism Industries. Domestic travel did witness a slight that the hotel demand recovery had legs. Over the comingsurge in 2010, but since that time it has diminished. The quarters, hoteliers are going to continue to trade awaydemand growth witnessed so far in the hotel recovery is accelerating demand growth for ADR growth, which isnot sustainable, given these trends in travel. another reason we will see demand growth for hotel rooms continue to diminish.Domestic or International Travel Causing Boost inDemand? Several factors, then, will cause demand growth to continue Domestic International to diminish in 2012. The historic demand growth ratePassenger Enplanements: Yr/Yr Growth (%) Hotel Demand of 10% at the onset of the hotel recovery was, of course, 30 unsustainable, and with growth having diminished for the 20 past several quarters, there is momentum toward further 10 slowing in 2012. A European economic crisis could put a significant damper on already-weakened international travel 0 to the U.S., which has been a driving force through much of -10 this hotel demand recovery, and accelerating growth in room rates will only compound the issue. But demand flattening -20 out in 2012 does not mean the end to the demand recovery; -30 demand for rooms will continue to expand, just not at the 1997 1997 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 boosted rates recorded coming out of the recession.Source: CBRE Econometric Advisors, BTA.The severity of the recent downturn caused room rates to TREND #7record historic, severe declines. When room rates stopped DEBT MARKET DISTRESS MOVES PASTdeclining at the end of 2009—at levels recorded in mid- PEAKS, BUT REMAINS HIGH2006—the downturn had taken almost three years worth of A Widening Window of Investmentpricing power away from hotel owners. Unlike in the 2001 Opportunity?recession, when demand declines were less pronounced, As 2012 unfolds, equity investors may continue to be wary Occupancy Growth Gives Way to ADR Growth of the competition and high prices paid for core assets, and some may rethink their strategy and risk/return parameters. APR Growth (R) However, debt investors that have capital to deploy may be 4 Qtr. Moving Avg. ADR APR Growth, YoY (%) well positioned to take advantage of growing opportunities$140 15 to finance first mortgages and strategically re- capitalize$130 10 maturing loans that are backed by quality properties. While$120 5 uncertainty regarding future upward movement in interest$110 rates is a concern for debt and equity investors alike, those$100 0 in the debt world may see an opportunity to earn favorable $90 -5 risk-adjusted returns—especially under a scenario where $80 -10 growth in property values stalls from downward pressure $70 on net operating income. Permanent first mortgage and $60 -15 mezzanine lenders will continue to benefit from a growing 1988.1 1989.1 1990.1 1991.1 1992.1 1993.1 1994.1 1995.1 1996.1 1997.1 1998.1 1999.1 2000.1 2001.1 2002.1 2003.1 2004.1 2005.1 2006.1 2007.1 2008.1 2009.1 2010.1 2011.1 2012.1 2013.1 2014.1 pipeline of loan maturities that will be in need of “gap”Source: CBRE Econometric Advisors. financing. January 2012 Page 13 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 What are some of the important trends that have emerged However, overall underwriting parameters appear in recent months that will set the stage for the real estate to have stabilized in recent months. CBRE Capital debt capital markets in 2012? Markets tracks the average loan-to-value (LTV) on new-issue, permanent, fixed-rate loans. (Exhibit 1)  Debt availability continues to improve, but the progress Exhibit 1: Loan-to-Value Rations Stabilize remains decidedly uneven. The CBRE Debt Momentum index indicates that lending volume almost doubled for Average LTV % Non-Housing Housing-Related the year ended in the third quarter of 2011. Despite 80 the gains, lending volume remains at less than one- 75 half of 2007’s peak level. The life companies and lending agencies (Fannie Mae, Freddie Mac) have 70 contributed disproportionately to this year’s gains 65 Average LTV for deals with and are likely to remain reliable sources of financing fixed rate permanent debt 60 in 2012. Bank lending also revived substantially over the course of 2011; lending conditions are likely to 55 remain constrained in secondary and tertiary markets, 50 however, as local and regional banks continue to 2003.1 2003.3 2004.1 2004.3 2005.1 2005.3 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 work through their distressed commercial real estate Source: CBRE Econometric Advisors. portfolios. After a period of tight underwriting standards that  The CMBS pipeline thinned this fall due to spread- lowered average commercial LTVs significantly during widening and uncertainty in the capital markets. The the recession, LTVs recovered markedly during 2010 withdrawal of a few key lenders from the CMBS sector and then stabilized over the course of 2011. Given has also raised additional concerns about future the sluggish recovery in real estate fundamentals, market growth. As a result, some observers fear that lenders are likely to remain generally risk averse; as 2012 CMBS origination volume will struggle to surpass a result, it appears that underwriting standards will be the approximately $31 billion originated in 2011. maintained in the near future. CMBS lending will be critical to improving liquidity in 2012, especially in secondary markets and among Distressed loan resolutions and loan sales have risen B-quality properties. over the course of 2011, which could continue to exert downward pressure on distressed property prices, which  competition has caused loan spreads to become Less have been flat to declining over most of 2011. (Exhibit more favorable to lenders: while quoted spreads on commercial fixed-rate permanent loans appear to Exhibit 2: More Downward Pressure on Distressed Property Prices to Come? have tightened slightly from this year’s highs recorded CPPI Distressed Property Price Index in August, they are still anywhere from some 40-75 Net Qtrly Distressed Property Resolutions ($ Bil.) (R) Repeat Sales Price Index Property Resolutions, $ Bil. bps wider than May’s lows, depending on property 250 25 type and loan-to-value ratio, according to Trepp. This largely follows the pattern in CMBS spreads which 200 20 evolved over the course of the year. At the same time, with the downward shift in the yield curve, borrowers 150 15 now benefit from lower all-in borrowing costs. 100 10 Underwriting parameters appear to have stabilized: 50 5 after a flurry of CMBS origination in the first half of 2011, CMBS investors began to object to lower 0 0 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 subordination levels amid looser underwriting standards and the reappearance of interest-only loans. Source: CBRE Econometric Advisors. January 2012 Page 14 © 2012, CBRE, Inc.14
    • Special Report: 12 Trends for 2012 2) With some $80 billion specially serviced loans in highly leveraged loans and development deals are likely need of resolution, and the prospect of additional to remain under a significant amount of pressure, which defaults among bank development deals, it’s likely may result in the continuation of high loan delinquencies, that we’ll see growing demand for opportunistic especially among CMBS issuers and banks. capital to resolve the pipeline of distressed deals. For example, the demand for refinancing previously matured CMBS loans and future 2012 maturities is expected to reach $70 billion—far above estimates TREND #8 of CMBS new-issue origination. Even with a fairly CONSTRUCTION MAY RETURN generous estimate that 50% of 2012 CMBS maturing SOONER THAN YOU THINK loans may be able to fully refinance, the pipeline of Single Tenant and Delayed Projects Bring unresolved loans will grow. Surely, many lenders Back New Building will be forced to extend loans, but many others may require some form of modification or disposition. In The recent downturn in the commercial property markets particular, nearly $15 billion of maturing CMBS loans was largely a demand-driven phenomenon, with businesses from the 2007 vintage—according to Trepp—could failing and returning empty space to the market. By prove troublesome. These 5-year loans were highly contrast, the commercial real estate downturn of the late levered and interest-only; many were underwritten 1980s and early 1990s was heavily supply-driven, with an to weak standards and rents at market peak levels. excessive quantity of new construction sitting as an anchor around the neck of property market performance for muchThe one aspect of the financial markets that will remain of the early 1990s. Many investors are banking on the factdiffi cult to navigate will be the prospect of continued that there is no such anchor holding back the commercialvolatility and uncertainty related to the European debt crisis. property markets today, and anticipating performance toThis will require additional patience and flexibility on the rebound sharply once demand returns.part of lenders, as borrowers are likely to pause frequentlyto re-evaluate strategies and bids in light of volatile capital We think that these investors are right to assume that themarkets. In addition, the heightened competition between shutdown of new supply will have an impact on propertylife companies and banks for the best quality deals in the market performance. All other things equal, any short-primary markets is likely to remain in place. Risk aversion term interruption of supply will push up rents for existingwill remain an important theme among first mortgage properties as tenants scramble to find suitable space.lenders in 2012, creating opportunities for mezzanine This said, we do believe that some investors are beinglenders that provide gap refinancing, as well as those that overoptimistic in this regard. Some assume that ourseek to re-finance deals in secondary markets. Single-Tenant Construction Returns First Historically Multi-Tenant, Vacancy Rate, %Several trends would seem to indicate that the debt markets Single-Tenant Shareare moving past a period characterized by distress, to an Multi-Tenant Vacancy Rate, % Single-Tenant Construction as a Share of Total %era where re-capitalization is the dominant theme. A recent 25 45plateau in CMBS and bank commercial loan delinquencies, 40sales of several international banks’ distressed U.S. lending 20 35portfolios, the gradual resolution of construction and 30 15development loan problems, and faster CMBS resolutions 25would seem to indicate that a period of peak distress 20 10 15may soon pass. Meanwhile, a modest recovery in values 5 10would indicate that borrowers and lenders are increasingly 5focused on re-capitalizing performing deals. However, 0 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013it appears that 2012 will be yet another transition yearfor real estate debt capital markets. With only modest Source: CBRE Econometric Advisors.improvement in market rents and occupancies expected, January 2012 Page 15 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 situation is such that will never see major new construction to conclusion. Among investors, there has been a move over the life of the target holding periods of many funds. toward risk aversion; this is especially true of lenders. This The fact is that there are a number of potential construction is not the same as saying that there is no capital available projects out there which might return quickly. for development; in fact, firms that might otherwise be tenants in commercial properties might in the end opt out Over the years, an economy demands new construction. of the rental market altogether. Firms grow and need to consolidate operations into a single location. Tastes and technologies change, and firms want As shown in the preceding chart, the share of all office to consolidate into open floor-plans or LEED buildings. construction that is purpose-built for single-tenants tends to Even in high-vacancy markets, such changing patterns of rise when the market is otherwise facing slack conditions. tenant demand can lead to new construction. In the Dallas When vacancy was high in the mid-1990s, the early office market for instance, even with vacancy rates in the 2000s and in this recent downturn, new construction was low 20 percent range in the four years from 2006 to 2009, shutting down and the share of new construction that was construction averaged 2.7 million square feet per year. The purpose-built, single-tenant space was rising. When the high vacancy was focused on assets that were functionally development market shuts down, the corporate tenants obsolete and new construction was needed to facilitate the who need new space will need to step up to the plate and demands of tenants in a growing economy. take on more financial responsibility for the space needed for their operations. Still, tenant demand alone is insufficient to drive major new construction. The financial markets are the issue The one period for which this relationship does not hold is today, with speculative development problematic, given in the period from 1985 to 1992, when vacancy was very a lack of easily accessible capital to bring these projects high and single-tenant construction was low. In that time The Inventory of Failed Developments Valued $100 Million and Greater Might Come Back from the Dead “Value” Square Feet x 1,000 Units No. of Projects RCA Sales 2011 Total Apartments 129,208,548,469 1.8 849,091 548 41,733,328,214 Hotel 50,954,310,621 22,789 230 16,764,794,592 Office 112,084,652,513 456,154 444 47,806,932,109 Retail 76,500,860,668 428,534 379 33,355,959,515 Warehouse 12,356,392,682 203,303 65 23,118,055,411 Abandoned Apartments 73,002,614,560 479,735 281 41,733,328,214 Hotel 25,961,451,002 113,512 105 16,764,794,592 Office 49,003,727,698 199,432 198 47,806,932,109 Retail 47,217,655,107 264,499 220 33,355,959,515 Warehouse 6,194,322,444 101,917 30 23,118,055,411 Deferred Apartments 56,205,933,908 369,356 267 41,733,328,214 Hotel 24,992,859,619 109,277 125 16,764,794,592 Office 63,080,924,816 256,722 246 47,806,932,109 Retail 29,283,205,562 164,036 159 33,355,959,515 Warehouse 6,162,070,237 101,386 35 23,118,055,411 Source: CBRE Econometric Advisors, Real Capital Analytics, November 2011 January 2012 Page 16 © 2012, CBRE, Inc.16
    • Special Report: 12 Trends for 2012frame, firms looking for new space would have needed when the commercial property markets come out of ana compelling reason to allocate capital to purpose-built extended downturn, and relative prices change.facilities when developers were still building and in somecases practically giving away the properties for free. Our CBRE colleagues in Tokyo tell us of what was termed, “The 2003 Problem”—when, after years of unwindingBy contrast, with developers and lenders in the current some of the excesses from the 1980s’ property bubble, themarket so risk averse and hesitant to commit capital to new massive reduction in land costs made development projectsconstruction, corporations may end up committing capital to financially feasible, even if market vacancy and new tenantsuch projects. Many corporations are carrying heavy cash demand were not calling for construction. The developmentbalances on their books, and some may opt to put some of boom that ensued added roughly 12 million square feet tothis capital to work in purpose-built single-tenant projects. the 23 wards of Central Tokyo in a single year. Again, theIf firms opt to pursue this path, their ability to undertake new market itself did not need the space; tenants were simplysingle-tenant projects will be aided by the sheer inventory of moved from one building to another as new investors endedfailed development projects that currently litter the market. up with old development sites at a lower going-in cost. As investors pursue yield in the U.S. today, does the marketThe preceding table, drawn from our CBRE EA/Dodge here face a similar risk?Pipeline report, highlights the fact that there is a substantialinventory of failed major development projects that never Our $100 million cutoff for the list above was not just anreached completion during the recent market boom. These attempt to reflect the large projects that a single corporateprojects include many for which entitlements are already in tenant might take on for its own use. Given that investorsplace and only a source of capital is needed to bring them are still hungry for yield in the current market and that thereback from the dead, so to speak. is some new tenant demand, some of what happened in Tokyo could happen in the U.S. While this would not likelyTo compile the list, we estimated a current “value” for each be to the same degree as in Tokyo—where the stock ofproject, using the product of the inventory of space or units office space grew 6% in a single year (“normal” growth wasin the project and the average national sales price for assets closer to 2-3%)—there is the risk that, as failed developmentbuilt since 2000, according to sales data published by Real projects trade hands, the reduction in development costsCapital Analytics. Included in the table are those projects will allow new projects to move forward, despite the dearththat were either abandoned or deferred in recent years and of construction lending.came in at $100 million or greater. Many investors are counting on the fact that the currentIn the office sector so far in 2011, there were about 30% shutdown of new competitive supply will help to boostmore projects deferred—i.e., put on hold until conditions property income in the short term. Again, we agree withimprove—than there were office buildings sold. The that thinking, and the forecasts presented in our Outlookpotential overhang is even greater in the hotel sector, where platform hold to this view over the next year or two.deferments were roughly 50% higher than all transactionsthrough November of 2011. Warehouses are relatively However, over a more extended period—one typical of theunder-represented here, owing to the short lead times holding periods for most funds in the U.S.—this convergenceneeded for construction. of views erodes. Some investors are making investments today, thinking that no new construction will come in overFaced with mounting costs and limited sources of five- or even ten-year horizons. These assumptions cannotconstruction and financing, the developers behind some of hold over such a time horizon, given the sheer quantity ofthese failed projects will either default outright or reduce failed development projects out there. At some price-point,their stakes by bringing on other capital partners—if the these projects will trade hands—such that the new ownersmarket works properly. As the interests in these projects will not need construction financing to move forward.trade hands, one investor will be taking a loss and the actualinput cost of the development will be falling for that nextinvestor. History shows us that funny things can happen January 2012 Page 17 © 2012, CBRE, Inc.
    • TREND #9 Special Report: 12 Trends for 2012 with retailers remaining circumspect about the consumer RETAIL RENTS FINALLY SEE BOTTOM recovery. Lagging Behind Other Property Types, Last Pieces Fall in Place The impact of the recent recession on retail sales is apparent when current levels are compared to pre-recession levels— The recent recession’s impact on the retail industry was particularly for the housing-related sales segments. All deep and lasting. Retail sales suffered as consumers pulled of the three major retail sales categories—necessities, back on their spending to focus mainly on purchases of housing-related and discretionary—declined in 2009 necessity goods. For retail centers, this translated into as consumers curtailed their spending. With consumers historic absorption drops and availability rate increases, least likely to dramatically alter their spending on daily and no center seemed immune. The retail demand recovery necessities, that category is the most stable; it wasn’t was slow to begin and has had a rocky start, but it has immune, however, and necessity-based spending dropped begun. Availability rates stabilized in 2011, but there is in 2008Q4 and 2009Q1. Drops were more substantial still a long way to go to reverse the damage done by the in discretionary sales (which, in 2009Q2, was down 11% recession. With the demand recovery just getting underway, from its 2007Q4 peak) and housing-related sales (which, we will need to see a couple of quarters of strong decline in 2009Q4, was down 35% from its 2006Q1 peak). in availability rates in order to see upward movement for rents. Fortunately, such declines are anticipated in 2012, All of the retail sales categories have passed their troughs and in the latter half of the year we expect to see the first and have begun to recover. Having experienced a less rent growth since the recession began. severe drop, necessity spending returned to expansion at the end of 2009, and as of the third quarter of 2011, the Leading up to and during the recent economic downturn, discretionary sales category has begun expanding as well. retail center availability rates increased significantly. As The housing-related sales sector has been recovering, but the housing crisis hit, retail centers saw the first signs at a slightly rocky pace, and sales remain 19% below their of consumers pulling back on spending; and once the previous peak. With consumers still unsure about the future retailers began to suffer, demand for space began to of housing values, they seem unwilling to invest in their decline. Availability rates were increasing by nearly whole houses at the pace they did prior to the housing crisis. Don’t percentage points by 2009Q1. Those increases continued expect the sector to regain its previous peak within the next until consumer spending showed signs of recovery, and several quarters; consumers won’t be filling new houses with in 2011, availability rates at all three center subtypes big ticket housing-related items in 2012. That said, recent stabilized. Demand momentum has been insuffi cient spending increases in private residential construction are to bring a huge downward shift for availability rates, concentrated in renovations and improvements (according however, and this lack of momentum will continue in 2012, All Retail Sales Segments Expanding, Except for Availability Rates Stabilizing in 2011 Housing Lifestyle & Mall Recession N&C&S Housing Change in Availability (%) Power Index, 2004 Q1 = 100 Discretionary Necessities 1.4 140 1.2 130 1.0 0.8 120 0.6 110 0.4 100 0.2 90 0.0 -0.2 80 -0.4 70 -0.6 60 2006.1 2006.2 2006.3 2006.4 2007.1 2007.2 2007.3 2007.4 2008.1 2008.2 2008.3 2008.4 2009.1 2009.2 2009.3 2009.4 2010.1 2010.2 2010.3 2010.4 2011.1 2011.2 2011.3 2000.1 2000.3 2001.1 2001.3 2002.1 2002.3 2003.1 2003.3 2004.1 2004.3 2005.1 2005.3 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 Source: CBRE Econometric Advisors. Source: CBRE Econometric Advisors. January 2012 Page 18 © 2012, CBRE, Inc.18
    • Special Report: 12 Trends for 2012to the Census), and a continuation of this trend should help 2012, declining only slightly. Retail center owners will gainto boost sales of building materials and other housing- some leverage by mid-2012, and in 2012Q3 we expectrelated merchandise. It will take a while for housing-related that rents will grow for the first time in four years, and thesales to work their way out of such a deep trough and back retail rent recovery will finally be underway.to their pre-housing crisis levels, but it looks like trendsand momentum have them moving in the right direction.These factors have forced a period of rent declines more TREND #10severe than any in our almost 20-year retail history. With MOVEMENT FROM TRUCKS TO TRAINSthe exception of 2008Q2, retail rents have consistently WILL BE INCREMENTALdeclined each quarter since the beginning of 2008, and Rise of Rail Inevitable, but Sloware expected to continue on this path for the majority of2012. This trend’s reversal is anticipated in 2012Q3, These past two years saw an impressive flow of eye-catchingspurred by absorption gaining momentum in 2012 as the reports highlighting significant commitments made by botheconomic recovery becomes more robust. Many retail the federal government and some states to redevelop ourcenter owners have been faced with high availabilities railroad infrastructure. The initiatives are mostly gearedover the past couple of years, and have been forced to towards improving our passenger train system, not the raillower rents in order to gain tenants. In some cases this freight system, with the goal of reducing the overall cost ofhas worked to the advantage of retailers; with higher-end commuting in and out of cities.space more affordable than in years past, some have seizedthe opportunity to upgrade their space. By the time the Some of the investments include the development offinal quarter of rent declines is recorded, rent levels will be high-speed train systems to be built over the next two15% below their previous peak and comparable to levels decades across 13 corridors, including Orlando-Tamparecorded in 2002q4. and Chicago-St. Louis. The Federal Government is expected to provide around $8 billion in funds, mostRent Growth by 2012Q3 of it to improve existing services. California has its own Rent Growth (L) ambitious $42 billion plan (to be partially funded by the Rent Growth, % Rent Level (R) Rent Level, $ federal government) to connect its major cities through a 1.5 $21.00 high-speed railroad network. 1.0 $20.50 $20.00 0.5 As we move into 2012, the question is whether these $19.50 investments will be enough to force a shift from truck 0 $19.00 shipment—currently the dominant method of transporting-0.5 $18.50 $18.00 goods—toward trains, and whether warehouse demand-1.0 Lowest Rent Since $17.50 will be affected at all. The answer is more intricate than-1.5 2002Q4, Down 15% from 08Q1 Peak $17.00 one may suspect and requires several layers of analysis.-2.0 $16.50 2006.1 2006.3 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 2012.1 2012.3 2013.1 2013.3 The first issue is regulatory. Up until the 1930s,Source: CBRE Econometric Advisors. transshipments in the U.S. relied heavily on trains to move everything from natural resources to high value-addedUnfortunately, much ground remains to be made up, merchandise. Beginning in the late 1940s, however,and the rent recovery will not lead to rent expansion until excessive regulation and the coming of age of the trucking2016/2017. This was a historic recession for the retail industry—with bigger trucks running on cheap gas andindustry and although the necessity and discretionary door-to-door delivery—undercut the rail industry, bringingsegments have recovered faster than housing-related, it to its knees by the early 1980s.all retail center types shared in the severity of the impact.With an expected slower and muted demand recovery, The deregulation set forth by the Staggers Rail Act in 1980,availability rates will remain close to their new peaks in enacted in response to the state of affairs at the time, January 2012 Page 19 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 U.S Railway System Industrial Occupied Stock SqFt Less than 136,481 136,481 - 340,749 Greater than 340,749 U.S. Railway Source: U.S. Department of Transportation, Federal Highway Administration, Freight Analysis Framework, version 3.1, 2010. brought about a 180 degree turn for the rail transport the expansion in passenger train demand will likely clog industry. The legislation paved the way for consolidations, the transshipment network in most urban centers as well, allowed owners to drop routes that weren’t profitable, and worsening existing traffic conditions in and out of major enabled them, by and large, to run the system as they markets. In Los Angeles, one of the busiest rail transport saw fit, as long as Amtrak continued to have access to the destinations in the country, the Alameda Corridor, an network. Rail norms were also eliminated for most cargoes, expressway rail for transshipments only, was completed as long as the shipments could also be transported by road. in 2002 in order to bypass around 200 grade crossings Over time, the changes in the regulatory framework led to (interceptions formed by rail tracks and roads or paths) in significant improvements in productivity among the biggest and out of the ports of Long Beach and L.A. This type of operators, increases in return to capital, and consistent expressway is not the norm, however. drops in rates for over 20 years. Currently, the U.S. rail shipment system is considered the best in the world—a fact The second question is that of efficiency. Rail shipments’ not to be taken lightly, given the enormous sums invested great advantage—and their biggest weakness—is size. On in rail systems overseas. As one would expect, the U.S. rail average, one transport train can carry a load equivalent system runs through most of our major industrial markets. to that of around 280 trucks. This significantly reduces the per-unit fixed cost of transshipments, thus allowing The much-needed improvements to our passenger railroad trains to transport goods with high economies of scale. system, however, could end up hindering the future of The longer the distance that goods are shipped, the lower the transshipment rail network, mainly for two reasons. the fixed costs and thus, the more competitive that trains First, an estimated $15 billion train-control system will become. The downside for trains is that other modes of have to be implemented in order to monitor the expected distribution, such as trucks, are typically more competitive increase in passenger train traffic, especially around major over short distances. urban centers. Such a regulatory mandate will likely raise transport rates further, beyond the increases witnessed Concomitantly, trucks are bound by the highway system, since the price of oil began to escalate in 2006. Second, which prioritizes connectivity between cities, not the January 2012 Page 20 © 2012, CBRE, Inc.20
    • Special Report: 12 Trends for 2012shortest route between end points. As a result, trains tend in and around urban centers. In other words, warehouseto travel shorter distances. To capture the difference that demand will expand if the price of gasoline keeps the costrouting imposes, ton-miles—the tonnage transshipped of commuting high, and faster, more efficient trains boosttimes the miles it travels—provides a more accurate demographic trends near urban centers.measure of transshipments by modes of transportation thattonnage does. As distances increase, the per-unit cost of Finally, we estimated the potential impact on warehousetransporting loads by train drops, allowing bigger loads demand by looking at the correlations between train andto be shipped, and vice-versa—shorter distances lead to truck transshipments and occupied warehouse stock. Ourincreasingly inefficient rail shipments. study found the presence of train shipments across major markets to be significantly correlated with occupied stockTon-Miles by Mode of Transportation as Percentage of and to be, on average, significantly more correlatedTotal than with trucks. This makes sense: trucks tend to pick Train up merchandise from distribution centers—many times Truck T-M by Mode of Transp / T-M by All Modes (%) All Other Modes supplied by rail shipments—to make customized deliveries Average Train, Truck 100 to individual businesses over relatively short distances. 80 The ultimate impact of current rail investment on warehouse 60 demand is still unclear. In the near term, 2012 will not witness any radical switch in the way we ship goods around 40 the country. What was delivered by trucks and trains last year will likely be delivered through the same modes in 20 2012. Moreover, constrained economic growth next year 0 will keep overall migration patterns to urban centers in More than 2,000 miles 1,000-1,499 miles Less than 50 miles 250-499 miles 100-249 1,500-2,000 miles miles 500-749 miles 50-99 miles 750-999 miles check. Until this is reversed, demographic trends will not meet the thresholds in consumer and passenger trainSource: U.S. Census Bureau. demand necessary to expand, in turn, warehouse demand. Nonetheless, the secular shift towards urban centers will goThe impact of distances travelled is compelling. Trucks on, albeit slowly, as labor demand in agricultural wanes andare by and large the chosen mode of transportation for higher wages continue to be made in and around cities. Theshort-distance deliveries. As distances increase, trains switch to trains will not be a matter of if but rather of when.progressively become the preferred mode of shipmentscovering anywhere from 500 to 1,500 miles (to put it incontext, transshipments leaving L.A. would be just shortof St. Louis after 1,500 miles; those leaving Miami would TREND #11end up in Boston). Goods transported for more than IN SPITE OF CAPITAL MARKET1,500 miles are relatively few in terms of tons, moved VOLATILITY, FINANCE JOB CUTS TOmainly by trucks and essentially exclude commodities. END BY MID-YEAR 2012Interestingly, train and truck represent basically the same Many Finance Sub-categories Have Seenproportion (40.2% and 40.1% respectively) of total tons- Losses Level Offmiles distributed throughout the U.S., in spite of the factthat trucks distribute significantly more tons than trains do. Despite steady improvement in occupancies and total office-using employment growth, the two categories ofMarkets that operate on regional distribution axes for office-using jobs produced mixed results in 2011. Whilemedium-to-long-range supply routes may witness an total office-using employment grew by 1% through theincrease in warehouse demand, given ongoing investments, first three quarters, it was mostly due to stronger hiring inif two conditions are met: (i) that the price of oil remains the office-using services category—mainly in companiesaround $100 a barrel and (ii) that improved efficiency and providing high-tech and professional and business services,capacity in passenger trains increases resident population as financial services providers continued to hand out pink January 2012 Page 21 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 slips for the fifth consecutive year. While office-using services By some estimates, global job cuts in the financial services jobs grew by 1.5%, office-using financial activities jobs fell totaled over 200,0001 in 2011. Though Europe was the by 0.3%. There were many headwinds facing banks and hardest hit region, layoffs were announced at U.S. banks financial institutions in 2011, which included volatile global as well, and include the likes of Goldman Sachs, Citigroup, markets amid sovereign rating downgrades (in Europe Bank of America and Morgan Stanley. Q3 2011 results for and the U.S.), a sluggish domestic housing recovery and large investment banks were the worst since the subprime regulatory changes from the Dodd-Frank Act. Will these crisis, as revenues fell due to cutbacks in proprietary events of 2011 continue to affect hiring trends at financial trading and capital-raising activity. Fortunately for office firms in 2012? Or will improvements in the domestic investors though, this hasn’t resulted in announcements of economy be enough to finally halt job losses for the sector, banks shedding space, as took place in 2008 and 2009. irrespective of global uncertainty and regulatory changes? In December more cuts were announced at Citigroup (4,500) and Morgan Stanley (1,600), though, with eventual Despite downside risks from Europe, the U.S. domestic reductions to occur in 2012. economic expansion should continue in 2012, helping payroll expansion in the more cyclical employment Despite a sour year in terms of revenue, we expect payroll categories of finance like Real Estate, Credit Intermediation cuts at financial firms to be nearing an end. Even with the and Insurance. Total credit growth (for both businesses and recent announcements, the rate of decline for office-using consumers) has improved since April of 2011, and future financial activities employment has eased since 2009. We improvements in home sales activity should be a boon for expect year-on-year job growth for office-using financial real estate lenders and brokers, as well as home insurers. activities to begin in the second half of 2012. The sector will Real Estate employment, which accounts for 20% of total continue to underperform office-using services, however, financial activities employment, will slightly outperform with annual growth of only 1.4% in 2012, compared to the rest of the subcategories of finance in 2012. The other 2.6% for services. subcategories’ respective shares are as follows: Credit Intermediation and Related Activities—36%, Securities, In 2012, Finance to Underperform Services Again Commodity Contracts and other Financial Investment and Office -Using Services Office Job Growth, YoY % Change Office-Using Financial Activities Related Activities—12%, Insurance Carriers and Related Activities—31%, and Funds, Trusts and Other Financial 6 Employment—1%. 4 2 Despite Recent Announcements, Financial Job Cuts are Nearing an End 0 Credit Intermediation & Related Activities -2 Securities, Commodity Contracts & Other Financial Investments and Related Activities Funds , Trusts & Other Financial Employment -4 Insurance Carriers & Related Activities Real Estate -6 Subcategories of Financial Activities Employment, YoY % Change 5 -8 4 2007.1 2007.3 2008.1 2008.3 2009.1 2009.3 2010.1 2010.3 2011.1 2011.3 2012.1 2012.3 2013.1 2013.3 2014.1 2014.3 3 2 1 Source: CBRE Econometric Advisors. 0 -1 -2 -3 Even if job growth at financial services firms disappoints -4 -5 in 2012 as it did in 2011, investors can take solace from -6 the fact that offi ce markets have been able to adjust -7 -8 to a long-term trend of the financial services sector 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3 2011 Q1 2011 Q3 2012 Q1 2012 Q3 underperforming the office-using services sector. For the Source: CBRE Econometric Advisors, Economy.com. 1 http://www.bloomberg.com/news/2011-11-22/wall- street-unoccupied-with-200-000-job-cuts.html# January 2012 Page 22 © 2012, CBRE, Inc.22
    • TREND #12 Special Report: 12 Trends for 2012sum of markets, financial activities’ share of total-officeusing employment has fallen from 35% in 1990 to 28% in CAP RATE COMPRESSION WILL END2010. This was especially evident in large markets that are Cap Rates Flat or Worse in the Next Twoconsidered to be financial hubs, such as New York, Boston Yearsand San Francisco. Headcounts in total financial servicesfor New York and San Francisco are 11% and 23% lower Over the past five quarters, capitalization rates forthan they were in 1990. Technological innovation, bank commercial properties in the U.S. have experiencedconsolidation and shifting of back-office jobs to smaller significant compression across all property sectors. Aftermarkets have meant that financial sector employment and their 2010 peak, cap rates have seen a steady downwardits share of total office-using employment have declined trend during this period, driven by a recovery in portfolioeven in markets considered to be financial hubs. Yet values. The value growth of these last five quarters has ledoffice occupancies have continued to grow there, as firms many investors to hope that, rather than being a simpleproviding high-tech and professional and business services correction, this bounce represents a driver of future assethave played a more significant role in hiring and in leasing value increases.office space. In 2011, many of the largest leases signed inNew York, San Francisco and Boston were from industries NCREIF Cap Rate Forecastother than financial services—software companies, Retail Multifamilyhealthcare and consulting firms among them—and the Industrial NCREIF Cap Rate % Officesame can be expected in 2012 and beyond. Recession 12 11Significance of Finance Has Eased Over the Years 10 1990 9 2000 8 Financial Activities as % of Total Office-Using Employment 2010 7 45 6 40 5 35 4 30 3 25 2 1999.4 2001.1 2002.2 2003.3 2004.4 2006.1 2007.2 2008.3 2009.4 2011.1 2012.2 2013.3 2014.4 20 15 Source: CBRE Econometric Advisors, NCREIF. 10 5 0 We argue that this optimistic view is incorrect, and that the New York Boston San Los Chicago Philadelphia Sum of Francisco Ange- Markets cap rate compression (and the attendant growth in valuesSource: CBRE Econometric Advisors. stemming from it) has come to an end. Furthermore, we argue that cap rates will remain flat for the next two to threeAll is not lost for finance, however! Banks and investment years, and that there is even a risk of a modest increase infirms will continue to play a significant role in many markets cap rates in certain markets and sectors.and submarkets, especially as the economy gains strengthand the need for financial intermediation picks up speed. Why would we take such a position, especially in view ofAlthough employment in the sector has underperformed the continuing low interest rate environment? It boils downoffice-using services during the recovery and remains to the expected behavior of the fundamental factors thatexposed to both external and internal risks, the more cyclical drive asset pricing, over the next three years. Let’s considersubcategories of finance should see payroll growth in 2012 these one at a time, starting with rental income.and beyond as the overall national economy and housingmarket improves. As the chart below shows, Net Operating Incomes (NOIs) are expected to either remain flat or drop slightly in the next three years, under our base case scenario. This weak performance will be driven by continued weakness in many January 2012 Page 23 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 rental markets and property types, and by the expiration Treasurys—one metric that measures risk aversion—remain of leases signed at higher rates between 2006 and 2008, high by historic norms and are expected to remain high, replaced with leases signed at current lower spot rates. under our base case scenario. As a result, further increases in asset values (and hence, drops in cap rates) are fighting Net Operating Income Index: History and Forecast against investors’ flight to assets that are safer than real Retail estate. It could even be argued that high risk premiums Multifamily Industrial could cause cap rates to perk up higher, depending on 1997 Q4 = 100% Office Recession the exact interplay between the interest rate effects, risk 180% aversion, and capital availability. This could happen and we 170% explore its implications under our financial crisis scenario, 160% 150% which calls for a severe shock from Europe (although not 140% a complete disintegration of the Euro Zone), constraining 130% capital markets, denting economic growth and causing a 120% temporary upward adjustment in cap rates. 110% 100% Another way to look at this phenomenon is to view 90% commercial real estate in context of other markets—most 1999.4 2001.1 2002.2 2003.3 2004.4 2006.1 2007.2 2008.3 2009.4 2011.1 2012.2 2013.3 notably, the rest of fixed income instruments. As spreads Source: CBRE Econometric Advisors, NCREIF. on other asset classes begin to widen again in response to the investors’ renewed worry about medium-term prospects While we do not forecast a drop in rents and increases for the economy, even high quality “core” real estate assets in vacancies for a majority of markets (rather, we expect will not be immune to the adjustment of expectations by slow recovery, with the speed of the bounceback varying by investors. property sector and market), the lease rollover effect will be strong enough in many cases to depress NOI performance The third major capital markets effect that we expect will for the next couple of years. As a result, expected rental have a negative impact on asset pricing is credit availability. income—one of the fundamental drivers of asset pricing— Credit availability was severely affected during the financial will likely remain weak on average in the next three years crisis. There has been significant recovery in debt since (with the notable exception of multifamily, which will have then, but the economy as a whole is still deleveraging. a stronger recovery). Our research indicates that debt availability is one of the strongest factors in determining asset pricing, and, as a While weak rental fundamentals will play a role in the result, the expected path of recovery in debt availability end of cap rate compression, the primary drivers of asset in the next three years will be instrumental in determining valuation will be capital market effects. On the positive the behavior of asset prices and cap rates during that side of asset pricing, we expect interest rates to remain low period. We expect a relatively slow recovery in leverage in over the next three years. Given current uncertainty around the economy, which will contribute to the end of cap rate the fallout from the Euro Zone crisis and the slow pace of compression (and a possible temporary cap rate reversion) economic recovery, the Fed is likely to continue its current in 2012. accommodative monetary policy during this period. This low interest rate environment will prevent cap rates from While our short-term outlook calls for lackluster performance rising significantly, even in spite of uncertainty around the of commercial real estate, our medium-term view is more capital markets. positive. We forecast that commercial real estate will deliver decent returns in the 5-year period, comparing favorably to This capital markets uncertainty, however, will likely most other investment alternatives. A large portion of that manifest itself in other ways. One such manifestation will return will come from income returns, since appreciation likely be subdued risk appetite on the part of investors returns will either not contribute to, or subtract from, the (and the degree of risk aversion is known to be a strong total return metric in the next two years. Subsequently, factor in asset pricing). Corporate bond spreads over U.S. values will start to recover, contributing to investment January 2012 Page 24 © 2012, CBRE, Inc.24
    • Special Report: 12 Trends for 2012performance. The bottom line is that while CRE will not postspectacular results in the short-term, it will still be a viableinvestment option, given the expected poor performanceof alternative asset classes.5-Year Average NCREIF Returns: Forecast Appreciation Return Average Return, % History (2011.4 - 2016.4) Yield Total Return 20 18 16 14 12 10 8 6 4 2 0 Office Industrial Multifamily RetailSource: CBRE Econometric Advisors, NCREIF. January 2012 Page 25 © 2012, CBRE, Inc.
    • Special Report: 12 Trends for 2012 CBRE GLOBAL RESEARCH AND CONSULTING This was report was prepared by CBRE Econometric Advisors, which forms part of CBRE Global Research and Consulting—a network of preeminent researchers and consultants who collaborate to provide real estate market research, econometric forecasting and consulting solutions to real estate investors and occupiers around the globe. CBRE Econometric Advisors CBRE Econometric Advisors (CBRE EA), as part of CBRE’s global research platform, provides commercial real estate research, advisory services and forecasting products to clients. CBRE EAs products and services cover the U.S. and a constantly expanding selection of global regions, as well as all spheres of the real estate market, including public, private, debt and equity. For more information regarding this report, or to find out more about any aspect of our services, please contact: Jon Southard Gleb Nechayev Director of Forecasting, Econometric Advisors Senior Managing Economist, Multi-housing and Director, CBRE Global Research and Econometric Advisors Consulting +1 617 912 5245 +1 617 912 5228 gleb.nechayev@cbre.com jon.southard@cbre.com Abigail Rosenbaum Jim Costello Senior Economist, Hotel and Retail, Managing Director, Americas Research and Econometric Advisors Director, Global Research and Consulting +1 617 912 5242 +1 617 912 5236 abigail.rosenbaum@cbre.com jim.costello@cbre.com Umair Shams Serguei Chervachidze Economist, Office Capital Markets Economist, Econometric Advisors Econometric Advisors +1 617 912 5249 +1 617 912 5218 umair.shams@cbre.com serguei.chervachidze@cbre.com Jared Sullivan Mark Gallagher Economist, Industrial Senior Strategist, Americas Research Econometric Advisors +1 617 912 5252 +1 617 912 5243 mark.gallagher@cbre.com jared.sullivan@cbre.com Diego Iribarren Luciana Suran Senior Economist, Industrial, Senior Economist, Global Econometric Advisors Econometric Advisors +44 20 7182 3348 +1 617 912 5204 diego.iribarren@cbre.com luciana.suran@cbre.com Arthur Jones Senior Managing Economist, Office Econometric Advisors +1 617 912 5229 arthur.jones@cbre.com Information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt its accuracy, we have not verified it and make no guarantee, warranty or representation about it. It is your responsibility to confirm independently its accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of CBRE Econometric Advisors. January 2012 Page 26 © 2012, CBRE, Inc.26