Good morning… As you saw in Scott’s slide we have been saying for several years now that this recovery would not be easy and indeed it’s turning into an endurance contest.
For 2012, we think the industry will face what amounts to a continuation of a long grind where returns for the best properties level off from recent spurts and commodity real estate continues in a limbo of non-recovery.
Many in the industry have been heartened by all the equity capital seemingly wanting into the asset class, but we adopt the cogent view of one interviewee who warns: Don’t let availability of capital cloud judgments-- demand drivers don’t exist and fundamentals need to catch up.”
The big question for everyone continues to be “Where is demand” for space?
The answer is in the Era of Less, the term we coined in last year’s report--businesses and people use less space per capita to help drive profits, save money, and live necessarily more frugally. It’s just not a prescription for a typical rebound.One interviewee’s comment helps drive home our discomfiting reality: “If you haven’t figured it out by now, this time is different.” Here’s Steve Blank to discuss the obstacles standing in the way of a robust rebound, the economy and capital flows.
The impact of global jobs arbitrage—that is the U.S. is the world’s high cost employer competing against lower cost countries that are taking our jobs, now not only manufacturing, but also in the service sector, enabled by telecom and internet technology.
Technology also has led to greater productivity, eliminating what once were good paying jobs like secretaries, travel agents, operators, mail men, and on and on.
Government debt and resulting budget cuts lead to jobs cuts—both public and private sector. With more people in debt, they spend less which hurts the economy—housing and retail in particular.
The country’s ageing demographics leads to higher health care costs and fewer workers supporting more dependents, not an equation that supports increased consumer spending
The housing downturn stanches the need for new construction, which had been a huge jobs generator.
The global financial morass is a major drain, impacting in particular the financial industry which heads into retrenchment.
And without a lot of ample and cheap credit to fuel transactions in an upward trending market, it’s hard to make big profits. The trading bizarre is over in the financial industry and the elimination of high paying jobs follows in due course.
Add to the job woes-- what amounts to dysfunctional government—while the two parties battle over power and ideology, the country sinks without constructive policy to address problems. Will healthcare reform survive the upcoming Supreme Court challenge? What will happen to Fannie Mae and Freddie Mac? What about implementation of financial regulation and potential changes in tax policy? Who knows?
Commodity properties—most of what’s out there--haven’t managed much of a recovery and won’t make much of a return next year. And legacy opportunistic investments where investors overleveraged will be wipe outs--it’s just a matter of time before lenders and borrowers must record their losses.
Our interviewees have been expecting interest rates to increase for years. It’s only Fed policy in reaction to the horrible economy that has kept rates at artificially low levels. In the meantime, the policy and the economy look “more Japan-y,” as one interviewee puts it. At some point interest rates will increase, and investors risk getting caught short with floating rate debt or refinancing at the wrong time.
Real estate looks like a good play because of classic spread investing over Treasuries. But our interviewees expect cap rates to flatten and even tick up in 2012 as fundamentals don’t respond—vacancies remain high and rents don’t move.
The real estate barometer, Emerging Trends most telling graphic, highlights how buy sentiment is suddenly declining at a time when you’d expect greater momentum, and sell sentiment is increasing. You’ll note the current dynamic looks more like 2009 at the depths of the recent crash than a market rebound scenario.
We expect transaction activity to remain relatively restrained… The prime gateway markets are priced to disappoint after some aggressive underwriting--prices and values get ahead of leasing and rent trends, which won’t materially advance enough to meet expectations.Investors hope they can find better deals in secondary markets, but relatively few opportunities exist and mostly what they find is greater risk in markets without much tenant demand.Everybody goes gaga over apartments, but pricing gets awfully rich and developers ramp up new building activity to compete with older product.Pickings in the distressed debt pile seem awfully thin—for every jewel there’s a ton of trash.
The reality is too much capital chases too little equity product, and gets frustrated. Our real estate markets really cannot satisfy potential capital demand, and when capital overshoots into the asset class problems inevitably follow. That’s what we saw four years ago, and we’ve seen signs more recently in the gateway markets.
On the debt side, our survey respondents expect a continuing dearth of capital flows, primarily because banks are holding back and CMBS markets have been slow to re-gear. Legacy problems and the difficult economy hold back lenders.
But interviewees cool their concerns about a refinancing emergency. Good credit borrowers with cash flowing assets will have no problems, and the extend-and-pretend game continues with many underwater assets, albeit foreclosures and give backs will steadily increase as lenders and special servicers can absorb take backs and execute on REO dispositions. The reluctance to drop the hammer on defaulting borrowers begs the question about how solid lender balance sheets really are.
Under the circumstances, underwriting standards will remain rigorous—lenders have no appetites to take risk while they contend with legacy problems.
For recent lessons learned, investors would be wise to follow the money. When it looks out of control—that is gets ahead of leasing and supply/demand trends—you know it’s time to retreat. Sub-5% cap rates should be an obvious red flag.
It was especially disconcerting this past summer when CMBS underwriting unhinged from reality so soon after the 2005-2007debacle. Interviewees suggest that for secondary and tertiary markets and more commodity real estate to advance, CMBS markets must make a comeback to levels where offerings range at $50 billion to $100 billion annual clip. That’s just not happening. We expect continuing consolidation among conduits and sponsors as smaller players get squeezed out. Essentially, it’s a low margin business with considerable risk involved in warehousing assets subject to market swings.
As noted, banks do a lot of extend and pretend, while insurers sit pretty in their lending niche for handling high credit borrowers who own higher quality properties in better markets. That approach has yielded much better portfolio performance—witness insurers’ lower default and delinquency rates.
Equity players will continue to look for opportunities. REITs probably have the strongest positions, holding onto their best properties and trying to sell off weaker assets into capital while buying interest allows.
So let’s conclude by looking at our Emerging Trends best bets for 2012—what real estate players should be doing to maximize their investment opportunities.
For starters, caution should rule next year… It’s not time to be all in—investors should maintain liquidity until the economy firms and the jobs picture improves. It’s hard to see how that will happen in 2012.
Indeed, as 2012 comes into focus—it will be another year in the Era of Less—facing up to a long hard grind.
Petree Hall (Dean Schwanke) - ULI fall meeting - 102711
Emerging Trends in Real Estate 2012 Longest published annual real estate outlook—33rd consecutive year Most predictive industry forecast Based on surveys/interviews with 950 industry leaders Jointly published by PWC and ULI
―Nothing lasts forever. No more easy money‖ ―Recent high leveraged buyers could get hammered‖ ―Real estate players must steelthemselves for a difficult, much slower than normal comeback‖
―Nothing lasts forever. No more easy money‖ Emerging Trends Fall 2006 ―Recent high leveraged buyers could get hammered‖ Emerging Trends Fall 2007 ―Real estate players must steelthemselves for a difficult, much slower than normal comeback‖ Emerging Trends Fall 2009
Emerging Trends in Real Estate® 2012 Presenters: Jonathan D. Miller Author Stephen Blank ULI, Senior Fellow Charles DiRocco Director, PricewaterhouseCoopers
Recovery in the ―Era of Less‖ ―If you haven’t figured it out by now, this time is different.‖
Obstacles to Real Estate Rebound Global jobs arbitrage Productivity’s costs Personal and governments debt loads Demographic realities Construction slowdown Global financial morass Financial industry recalibration
Ebbing Return Expectations 2010 Core: Take chips off the table 2011 Core: Mid to high single digits REITS: Mid to high single digits Commodity properties: Flat to low single digits Legacy opportunity: 0%+ Opportunity: High risk, slipping expectations <15%
Commercial Property Price Index All Properties—National Index 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 01 02 03 04 05 06 07 08 09 10 11 Source: Moody’s, Real Estate Analytics LLC, MIT Center for Real Estate, Real Capital Analytics. Note: This index is a periodic same-property round-trip investment price change index of the U.S. commercial investment property market. The index is based on the Real Capital Analytics database, which attempts to collect price information for every commercial property transaction in the United States over $2.5 million in value.
Interest Rates Inflation and Interest Rate Changes Increase substantially 2012 Next Five Years Increase moderately Remain stable at current levels Inflation Short-term rates Long-term rates Commercial (1-year (10-year mortgage rates treasuries) treasuries) Source: Emerging Trends in Real Estate 2012 survey.
Cap Rates NCREIF Cap Rates vs. U.S. Ten Year Treasury Yields 10% 8% 6% Cap Rate 4% 10-Year Treasury 2% Spread 0% 1992 1995 1998 2001 2004 2007 2010 -2% -4% Sources: NCREIF, Moody’s Economy.com, Federal Reserve Board, PricewaterhouseCoopers LLP. *Ten-year treasury yields based on average of the quarter; 2011Q2 average is as of August 31, 2011.
Real Estate Barometer987 Buy65 Hold4 Pre-recession Sell3 Post-recession21 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Emerging Trends in Real Estate 2012 survey.
Transaction Activity Restrained Gateways: Priced to disappoint, recovery needs to catch up Secondary markets: Looking for relative bargains, finding higher risk Apartments: Everybody goes gaga Distressed debt: Slim pickings
Too Much Equity Equity Capital For Investing 39.1% 22.5% 17.2% 14.0% 7.3% Substantially Moderately In balance Moderately Substantially undersupplied undersupplied oversupplied oversupplied Source: Emerging Trends in Real Estate 2012 survey.
Too Little Debt Debt Capital For Acquisitions 43.1% 22.9% 20.2% 12.5% 1.4% Substantially Moderately In balance Moderately Substantially undersupplied undersupplied oversupplied oversupplied Source: Emerging Trends in Real Estate 2012 survey.
No Refinancing EmergencyMaturing Loans: Preferred Strategy for Lenders CMBS Delinquency Rates Extend without mortgage 10% modification Foreclose and dispose Delinquency rate 6% 15% 8% 6% 4% Delinquency rate average 2%Extend with 0% mortgage 99 00 01 02 03 04 05 06 07 08 09 10 11modification Sell to a 54% third party 25% Sources: Emerging Trends in Real Estate 2012 survey, Trepp LLC. * Through August 2011
Rigorous Underwriting Standards Equity Underwriting Standards Forecast for U.S. 46.7% 30.5% 22.8% More Rigorous Will Remain the Same Less Rigorous Source: Emerging Trends in Real Estate 2012 survey.
Follow the moneyWhen it looks out of control, retreat
CMBS Snafu U.S. CMBS Issuance Total ($M) 250 200 150 100 50 0 97 99 01 03 05 07 09 11* Source: Commercial Mortgage Alert. * Issuance total through August 31, 2011.
Banks and Insurers U.S. Life Insurance Company MortgageBank Real Estate Loan Delinquency Rates Delinquency and In-Foreclosure Rates %20% 8 Delinquency 7 Construction and Development Loans15% 6 Noncurrent Rate 510% 4 Multifamily Mortgages Noncurrent Rate 3 Commercial Mortgages 25% Noncurrent Rate 1 In Foreclosure0% 0 91 94 97 00 03 06 09 90 93 96 99 02 05 08 11 Notes: Delinquent loans are defined here as those that are noncurrent— Sources: Moody’s Economy.com, American Council of Life Insurers. either 90 days or more past due or in nonaccrual status. As of Q2 2011. Source: FDIC.
Equity Players Change in Availability of Capital for Real Estate in 2012 Foreign Investors 6.23Private Equity/Opportunity/ Hedge Funds 6.00 Institutional Investors/ 5.95 Pension Funds Nontraded REITs 5.65 Private Local Investors 5.60 Public Equity REITs 5.56 1 5 9 Very Large Stay the Same Very Large Decline Increase Source: Emerging Trends in Real Estate 2012 survey.
Pension Funds Talk: Income returns Walk: Shoot for more to fill liability gaps I need stable income returns. Denominator effect back
Foreign InvestorsForeign Net Real Estate Investments US$ M 1500 Europe (ex. Germany) 1000 United Kingdom Middle East 500 Americas Germany Canada Other Asia 0 -500 -1000 Despite tenuous markets, the USA looks relatively safe Source: Real Capital Analytics Note: Net capital flows from second-quarter 2010 through second-quarter 2011. All dollars in millions.
Markets to Watch Only one of 51 surveyed markets fails to improve score over 2011 Prospects continue to improve for markets across the country “Most markets have stopped deteriorating, but most haven’t really improved.”
Trendy Emerging TrendsStandard Feathered–friend Color market finders Coding
Markets: 2011 Emerging Trends 2012 Source: Emerging Trends in Real Estate 2012 survey
Top 10 Markets: 24 Hour Gateways Again 2012 2011 1. Washington D.C. 6.93 7.01 2. Austin 6.92 6.29 3. San Francisco 6.92 6.34 4. New York 6.85 6.56 5. Boston 6.60 6.20 6. Seattle 6.60 6.09 7. San Jose 6.58 6.08 8. Houston 6.46 6.02 9. Los Angeles 6.30 5.84 10. San Diego 6.17 5.63Source: Emerging Trends in Real Estate 2012 survey
Most Walkable Cities Do Better New York City San Francisco Boston Seattle Washington D.C. San Jose Austin 0 20 40 60 80 100 ―24-hour Conveniences‖ Source: Walkability data provided by Walk Score®, www.walkscore.com. Notes: Scores are on a scale of 0 (car dependent) to 100 (walker’s paradise). NA = not available.
Energy and Tech Markets Excel2. Austin3. San Francisco5. Boston6. Seattle7. San Jose8. Houston11. Denver12. Dallas13. Raleigh-Durham Source: Emerging Trends in Real Estate 2012 survey
So Bigger is Better?Population > 3 Mill. 2.0 – 2.9 Million Population < 2 Mill.
East Coast Boston 6.60 Westchester/ Fairfield, CT 5.74 Providence 4.20 Northern NJ 6.10 New York 6.85 Baltimore Philadelphia 5.44 Pittsburgh 5.16 5.44 Washington DC 6.93 Source: Emerging Trends in Real Estate 2012 survey
West Coast Seattle 6.60 Portland 5.81 Sacramento 4.20 San Francisco 6.92Honolulu 5.47 San Jose 6.58 Los Angeles 6.30 Inland Empire 5.30 Orange County 6.01 San Diego 6.17 Source: Emerging Trends in Real Estate 2012 survey
Southwest Salt Lake City 5.17 Denver 6.16 Las Vegas 3.91 Albuquerque 4.43 Oklahoma City 4.61 Phoenix 5.45 Dallas 6.10 Tucson 4.21 Austin 6.92 Houston 6.46 San Antonio 5.83 Source: Emerging Trends in Real Estate 2012 survey
Southeast Virginia Beach/Norfolk 4.93 Raleigh/Durham 5.96 Charlotte 5.58 Nashville 5.32 Memphis 4.22 Atlanta 4.65 New Orleans 4.54 Source: Emerging Trends in Real Estate 2012 survey
Florida Jacksonville 4.48 Orlando 5.19 Tampa 4.79 Miami 5.81 Source: Emerging Trends in Real Estate 2012 survey
Midwest Minneapolis 5.38 Milwaukee 4.33 Detroit 2.88 Chicago 5.57 Cleveland 3.48 Columbus 4.03 Indianapolis 4.76 Kansas City 4.73 Cincinnati 3.97 St. Louis 4.48 Source: Emerging Trends in Real Estate 2012 survey
Value-Add Plays B-quality apartments in good infill markets “that haven’t been shown any love”
Fixed Rate Debt Lock-in long-term fixed-rate financing on assets, while interest rates stay low.
Recap Troubled EquityThe number of borrowers with decent assets needing refinancing only grows as troubled loans from the market lending peak reach terms.At low interest rates, investors can achieve especially favorable risk-return spreads.
Distressed Debt The hard part is figuring out if the good assets in offerings are worth acquiring given all the accompanying stuff
Land“These are real steals but purchasers must be prepared to wait before homebuilding comes back.”
Multifamily Any Way You Like It “Even buy class C and upgrade, spend a little more, hold a little longer, demand will be there.”U.S. Apartment Investment Prospect Trends U.S. Multifamily Completions/Vacancy Rates ThousandsRating of units Vacancy Rate % 250 Completions 8 8 Vacancy Rate % 200 7 7 Apartment Rental: 150 6 Moderate Income 6 100 5 5 50 4 Apartment Rental: High Income 4 0 3 2004 2005 2006 2007 2008 2009 2010 2011 2012 94 96 98 00 02 04 06 08 10 12* 14* Sources: Emerging Trends in Real Estate 2012 survey, REIS * Forecast
Coastal Port Industrial U.S. Industrial Investment Prospect Trends87 Warehouse Industrial6 R&D Industrial54 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Emerging Trends in Real Estate 2012 survey.
Business Center Hotels “It’s the point in cycle where lodging makes sense”-- only the major 24-hourU.S. Hotel Investment Prospect Trends U.S. Hotel Occupancy Rates and RevPAR 80% Occupancy % $808 RevPAR $707 60% Full-Service Hotels $606 40%5 Limited-Service $50 Hotels 20%4 $403 0% $30 2004 2005 2006 2007 2008 2009 2010 2011 2012 96 98 00 02 04 06 08 10 12* Sources: Emerging Trends in Real Estate 2012 survey. Smith Travel Research (1987 to 2010), PricewaterhouseCoopers LLP (2011 and 2012).
Improving ProfitabilityProspects for Profitability in 2012 by Percentage of Respondents 1.6% 1.3% 4.7% 6.1% 23.5% 20.8% 26.0% 11.0% 4.9% Abysmal Very Poor Poor Modestly Fair Modestly Good Very Good Excellent Poor Good Source: Emerging Trends in Real Estate 2012 survey
Emerging Trends in Real Estate® 2012 Panel Discussion Moderator: Douglas Poutasse Executive Vice President Bentall Kennedy Panelists:Michael Covarrubias David Lynn Diana ReidChairman and CEO Managing Director Executive Vice President TMG Partners Clarion Partners PNC Real Estate
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