2009 The Year Ahead
Posted: Jan 30, 2009
Investment sales in 2008 started off at an anxious pace as investors were figuring out where the market was going and trying to complete transactions at the same time. As the year progressed, the market’s direction became clear and activity diminished accordingly. According to Real Capital Analytics, U.S. investment sales over $5,000,000 during 2008 fell 56% from 2007 to $1,518,600,000.
Institutional investors are facing not only the denominator effect, but for the first time in a long while many are facing redemption requests from their clients. In times like these, where there is an absence of transactions, institutions tend to be very cautious. They do not want to make a wrong decision.
Capitalization rates initially decreased in the 1st quarter and then increased inconsistently throughout the year. The changes varied by property type and market. Office, industrial, and retail cap rates are up +/-50 bps in 2008 and apartments are up 25 bps. Cap rates and going-in IRR targets are increasing. According to PricewaterhouseCoopers, the going-in IRR spread between institutional and non-institutional grade properties is generally in the range of 200-225 bps across all property types. Today, there exists a bid-ask gap between buyers and sellers, which often is too big to close and properties are being pulled from the market. The lack of available debt and the deteriorating property fundamentals are the two biggest reasons for the upward cap rate movement. This condition is likely to persist throughout 2009.
Retail
The retail sector is the least favored by investors today. How quickly things change. Real Capital Analytics reports a 67% drop in dollar volume of retail investment sales during the past 12 months. There were 32 sales in the Minneapolis metropolitan area during this period at an average price per square foot of $126 and average cap rate of 7.4%. Minneapolis ownership is dominated by private investors. Malls and Power Centers tend to be on the bottom of buyers’ shopping lists. If any retail type is on the list, it is well-located grocery anchored centers.
Economic conditions are felt first by retailers and followed by their landlords. 2008 will set a record for the number of store closures and lease restructuring requests from national chains to the mom and pop stores. The bid-ask gap is largest in the retail sector. The active investors are underwriting on today’s rents and practically ignoring in-place rents, unless it is from a creditworthy
tenant with term left on the lease.
Office
As the fundamentals of the office markets weaken, so do expectations about future rents and ultimately prices adjust downward for investors to achieve the same yields. Cap rates are generally up 40-50 basis points from a year ago. According to Real Capital Analytics, the dollar volume of sales in the Twin Cities fell 66% from the end of 2007, while nationally the figure is down 68%. The average price per square foot in Minneapolis was $115 with an average cap rate of 7.59%, well above the 6.53% national average. Notable sales are featured in the office section. The larger sales are noticeably absent. Numerous office buildings (225 South 6th, Dain Rauscher Plaza, City Center, France Place, Edina Office Centre, and Midwest Plaza) were pulled off the market this year as sellers could not achieve their target prices.
Nationally, according to Korpacz Investor Real Estate Survey, suburban office cap rates average about 52 bps higher than their CBD counterparts. Investors think there is an advantage to attracting and retaining tenants, particularly large credit tenants, due to the advantages of mass transit, proximity to housing, and retail amenities in the CBDs.
Industrial
The industrial investment market adjusted to market changes faster than the other property types and is reflected in its sales activity. While declining on a year-over-year basis, it took less of a drop. Sales volume is down 19% in Minneapolis according to Real Capital Analytics, compared to 46% nationally. Reasons for the activity include a rise in cap rates from the low 7’s to the low to mid 8’s, and REIT sellers who were even willing to carry short term seller financing to get sales closed. The average price per square foot was $69. Private investors made 58% of the acquisitions. The bulk of the sales activity occurred in the first half of the year, with owner/user buildings in the highest demand.
Net Leased
The compression of cap rates for the risk taken is over. A return to the basics is occurring with investors again looking at what makes a good real estate investment: location, market trends, quality of the improvements, and does the concept/pricing/product of the tenant make sense for the long term. Cap rates are edging up. There is less new product being developed and hence less on the market. There are also fewer buyers, as a significant part of this market is driven by the back-end needs of 1031 exchange buyers, whose front-end property sales have declined. There are companies who are having trouble accessing the debt markets, and are now turning to the sale-leaseback market to raise capital.
Hotels
The dollar volume of hotel sales nationally dropped to a level last experienced in 2004. In 2007, there were approximately $77 billion of hotels sales in the U.S., according to Real Capital Analytics. For 2008, the volume will be about $11.5 billion. The economic downturn and lack of financing are the two main factors for the increase in sales. For the Twin Cities, the year-end sales volume is $55,200,000 and all are limited service hotels. All of the purchases were made by private investors. Cap rates for these sales averaged in the high 9%s. Cap rates for limited service hotels have risen nationally by 50-75 bps from a year ago according to RCA. See the adjoining table for metro area 2008 hotel sales.
2009 Outlook
A recent survey conducted by the Colliers Investment Services Group indicates that 22% of investors surveyed foresee being active buyers in the first half of the year. Seventy-eight percent said they would not venture back until the second half of 2009. Many want to know where the bottom is before buying. Leveraged buyers are mostly on the sidelines waiting for the debt markets to reopen. Sellers do not want to put properties on the market when there is a shortage of buyers to create a truly competitive market.
Investors with capital and access to debt will be able to make good buys on all property types and situations from opportunistic to value-add to core. The long term players are active, while the distressed asset buyers are doing more watching and waiting than buying. They know the number of foreclosed properties will grow throughout 2009 and into 2010, and therefore are being selective. There are distressed sellers emerging. Their properties may be good quality, but the loans on them are coming due and there are no refinancing options available. Compounding that problem is the fact that many of these properties were bought at the height of the market and are not worth what they were purchased for. (See the Real Estate Finance Section of this 2009 Report for capital market outlook.) Look for the private investors to be the most active buyers in 2009. Despite this group’s love affair with debt, they still find a way to make deals, especially when they are getting one.
Real Capital Analytics has identified $106 billion of distressed and potentially troubled assets. $4.5 billion of these have already gone back to the lender, and $21.2 billion are troubled in some manner: foreclosure, bankrupt borrower, past due on payments or loan maturity, major tenant bankruptcy, or slow sell out. Retail properties have the most potential for trouble ahead.
Distressed opportunities are coming from every investor type and every size. Look at General Growth, who is selling some of their trophy holdings to pay off maturing debts, or Lightstone Group, giving shopping malls back to its lenders, or the small partnerships that are being foreclosed for a variety of reasons. It seems no one is immune. Even Calpers will take over a billion dollars of losses on ill-timed land investments. The FDIC is auctioning off the assets they took over from failed banks.
There is a direct correlation between job losses and vacancy in office and industrial properties. Nationally, vacancy rates are expected to peak at 8.5%. This is going to lead to more vacancy and space for sub-lease. These weakened fundamentals will further erode property values and the ability of borrowers to re-finance existing debt. (See the Office and Industrial Sections of this 2009 Report for the graphs showing the correlations for the Minneapolis-Saint Paul market.)
According Brian Beaulieu of the Institute for Trend Research, the housing market will start coming back in 2010 and the commercial market in 2011. Commercial real estate this year hit the downhill side of the cycle and has a long way to go before hitting bottom. According to Mr. Beaulieu, 2010 will be the best time to buy. Vacancies will be up, values at their worst, and interest rates still attractive. Once the recovery starts, the anticipatory debt markets will smell inflation ahead and begin raising interest rates. In summary, buy low, load up on low interest debt, and let inflation (real estate’s friend) do its thing.
Click here for printable version
« National Forecast Predict Bleak 2009 for Commercial Real Estate | Who Has The Money? »
