NEW YORK, Jan. 7, 2008 (PRIME NEWSWIRE) -- Continued instability in the financial markets and ongoing uncertainty about the state of the U.S. economy will challenge investors throughout the commercial real estate industry during the next year, according to the 4Q 2007 edition of PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r).
"The recent subprime mortgage upheaval and the resulting global credit crisis are causing many players to be in limbo about pricing and about committing to new investments," said Tim Conlon, U.S. Real Estate leader for PricewaterhouseCoopers. "As a result, many respondents are suggesting that in 2008 we may see a period of time in which fewer transactions are completed, underwriting standards tighten, marketing times increase, and cap rates and sales prices undergo requisite adjustments."
At the same time, the degree to which these events affect individual markets -- as well as specific properties -- will vary greatly depending on underlying fundamentals and property characteristics, the report notes.
"One of the key challenges that buyers and sellers will face in 2008 is how to deal with the current price correction taking place," said Susan M. Smith, editor-in-chief of PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r) and manager in PwC's real estate business advisory services group. "The fact is, the commercial real estate industry's fundamentals have remained relatively healthy -- something that tends to be overshadowed by the current debate regarding price corrections -- but which could actually help soften the correction over the long term."
While it is still too early to determine the extent to which property values will correct, for now it appears that stabilized, quality assets are receiving the most attention from buyers, and are seeing little, if any, adjustments in cap rates and sales prices, the report notes.
Other key findings include:
* Thanks to continued low vacancy rates and limited additions to supply, tenants in many markets are left with only limited options for relocating. As a result, tenant retention percentages increased in 17 of the surveys' 21 markets during the past year, with the largest gains being realized in San Francisco and Houston. Overall, office markets that reported the lowest average underlying vacancy rate and credit loss this quarter were Washington, DC, northern Virginia and suburban Maryland.
* Central business district (CBD) markets that endured some of the highest increases in overall vacancy between the second and third quarters of 2007 included Orange Country, CA, Fort Lauderdale and Fairfield Country, CT. By comparison, CBD markets that posted some of the highest decreases in vacancy included Silicon Valley, Baltimore and Orlando. Suburban markets that endured some of the highest overall vacancy increases included California's Inland Empire, Orange County and Oakland. By comparison, suburban markets that posted some of the highest decreases included the San Francisco peninsula, Seattle and Boston.
* Overall capitalization rates (OARs) remain low in most markets, compared to last year. Although most average OARs saw declines on a quarterly basis, the amount of the decrease has shrunk considerably over the past few quarters. At the same time, the average OAR has held steady over the past three months in some of the best-performing office markets, such as Manhattan and southeast Florida.
Additional findings by sector include the following:
Retail
Rising amounts of personal debt, combined with higher gasoline and energy costs, have finally slowed down the spending habits of most consumers, especially those in the middle-class and lower-end ranges. As a result, many investors are opting away from investments involving older Class-B and Class-C regional malls. At the same time, high-end "true luxury" retailers that cater to the ultra-wealthy will probably see continued strong growth, while "affordable luxury" retailers that target both wealthy and middle-income consumers will see a drop-off, the report notes.
A drop in consumer spending is also having negative effects in the national power center market, although properties located in high-growth locations and affluent areas should fend better. Accordingly, a number of big-box retailers reportedly are making downward adjustments to their retail sales expectations.
An uptick in U.S. retail vacancies, combined with a decline in consumer spending, is giving would-be investors in the national strip shopping center market increasing concern. During the third quarter of 2007, the vacancy rate for U.S. strip centers rose to 7.4%, as compared to 7.3% in the second quarter of 2007 and 6.9% in the first quarter of 2006. With as much as 26.2 million square feet of additional new space expected to come on line by the end of 2007 -- and with a slowdown in absorption expected thanks to the drop in consumer spending -- that vacancy rate is not expected to decline anytime soon.
Office
Despite a slowdown in leasing activity and net absorption, the national CBD office market remains in good condition thanks to high construction costs and limited additions to supply. In 24-hour cities with high barriers to entry and strong diverse employment bases, such as Manhattan, Boston, Seattle and Washington, DC, overall vacancy rates remain in the single digits.
In the national suburban office market, many landlords have see a slowdown in activity from both new and existing tenants -- a factor that compels a number of respondents to anticipate rising levels of overall vacancy in the sector. At the same time, cap rates have remained relatively steady across the board with some movement apparent in select individual markets. During the next 12 months, survey respondents expect property values to increase as much as 5 percent in the national suburban office market. The report suggests that some of the best office investment opportunities in the near term exist in Boston, Seattle, southern California, Bellevue, WA, and northern Virginia.
Industrial
The national flex/R&D market is seeing added interest from some investors, thanks to a spurt in activity in the high-tech sector and the existence of supply-demand imbalances that favor landlords in many warehouse and suburban office markets. Of particular interest to investors are flex/R&D properties located in long-established tech markets such as Austin, Silicon Valley, La Jolla and Seattle.
Fundamentals in the national warehouse market remain relatively balanced thanks in large part to continued global demand for U.S. manufactured goods. Although the weakness of the U.S. dollar makes it more expensive for U.S. distributors and consumers to import goods, it helps boost demand for U.S. exports. As a result, domestic manufacturers with international operations continue to perform well and require warehouse space. Top markets in this sector are global pathway markets that feature access to dominant ports, a vast interstate highway system and close proximity to international airports, including Portland, northern New Jersey and South Florida.
Apartments
An emerging "shadow market" -- shadow rentals undertaken by owners of condos and single-family homes thereby diluting the rental pool for apartments -- has already impacted many metro area apartment markets, the report notes. The effects are most severe in areas that have already gone through the condo craze and are experiencing condo reversion, as well as in metro areas with an oversupply of single-family homes thanks to the recent subprime crisis and resulting distressed residential market. Even so, many investors still prefer apartments as an asset class for solid long-term returns. While third-quarter sales volume for the apartment sector was down 8 percent compared to September 2006, sales volume was down 40 percent for the office, retail, and industrial sectors during the same period. Regions with the greatest dollar volume of sales through third quarter 2007 were the northeast and the southwest, led by Manhattan and Phoenix.
Net Lease
Higher debt costs and increasing economic uncertainty has raised concern that the pool of buyers could diminish in the near future, the report notes. As a result, the number of assets available for sale in the national net lease market (24,224 properties) grew 14 percent in the third quarter of 2007 -- nearly double the growth reported for the previous quarter. Retail properties led the way (12,182 properties), followed by office (7,802 properties), and industrial (4,240 properties). All told, the number of net lease properties sold increased 20 percent in the third quarter of 2007.
National Development Land
During the recent economic expansion the high cost of construction materials and labor resulted in a relatively moderate development environment. As a result, there exists a relatively healthy balance between supply and demand in most property sectors. In the coming months, tighter debt markets and more stringent underwriting standards should enable the industry to maintain its current balance even amid an overall slowdown in tenant demand. In the coming year, the following are "best bets" for development:
* Think Green: Development of state-of-the-art sustainable buildings.
* Focus on Mixed Use and Infill: More 24-hour residential environments closer to work locations; pedestrian-friendly layouts offering varied living options -- condo, single-family, apartments, as well as service retail including grocery stores, pharmacies, cleaners and restaurants.
* Build Transit-Oriented Development: Condominiums, apartments and retail near light-rail or subway/trains stops -- a long-awaited response to growing traffic jams and car-dependent lifestyles.
* Buy Residential Building Lots: In the current "down" residential market, overly aggressive homebuilders are selling inventories of residential land tracts for cents on the dollar.
PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r), now in its 20th year of publication, is one of the industry's longest continuously produced quarterly surveys. The current report provides detailed overviews of 29 separate markets, including the national retail markets (regional mall, power center and strip shopping centers); overviews of 18 major office markets, including the recently added markets of Charlotte (new this issue), Denver, Phoenix and San Diego; and national overviews of the CBD and Suburban Office, Flex/R&D, Warehouse, Apartment, Net Lease and National Development Land Markets, as well as a special report on Medical Office Space. The report also features up-to-date commentaries concerning Valuation Issues, Technology News and Trends and Economic News. This edition also features guest commentaries on Real Estate Capital Markets by Bob White, president of Real Capital Analytics, Inc., and the Domestic Self-Storage Market, by Charles Ray Wilson, CRE, MAI and founder of Self Storage Data Services, Inc.
Information about subscribing to PricewaterhouseCoopers Korpacz Real Estate Investor Survey(r) can be found at www.pwcreval.com. Members of the media can obtain an electronic copy of the full report by contacting Thomas Derr at thomas.derr@us.pwc.com or (646) 471-8268.
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