US view: Investors see stability in CRE despite weak recovery

By Randy Drummer - Thursday, September 29, 2011 7:09

Investors on the other side of the pond are still seeing stability in commercial real estate despite the weak recovery and dampening sentiment for the asset class according to two wide-ranging reports, writes CoStar's Randy Drummer.

Investors surveyed by PricewaterhouseCoopers (PwC) continue to see commercial real estate as a relative brightspot but stubbornly high unemployment and economic volatility has clearly dampened enthusiasm for the asset class since the start of 2011. The declining sentiment comes even as rents, values, absorption and occupancy levels have slowly improved.

Meanwhile, a different study of commercial property net operating income (NOI) by Fitch Ratings showed that the sector still has quite a way to go before it completely shakes off the effects of the Great Recession.

Overall NOI was still down by 1% from year-end 2009 to year-end 2010, but has shown an improvement from the prior year-of-year decline of 5%, and "one year of greater NOI stability does not mean a recovery," Fitch Senior Director Adam Fox noted.

Responses from the more than 200 institutional investors surveyed by PwC during the third quarter reflected the volatility in the financial markets, the global sovereign debt crisis, the US rating downgrade, and fears by some economists of a possible double-dip recession.

"There is little doubt that we have entered a period of slower growth and greater uncertainty," leading to concerns that continued business and consumer insecurity will disrupt the slow-but-steady real estate recovery, said a respondent.

"Today, many investors are less confident in the industry's future than they were six months ago," another respondent said.

Even as rent growth remains frustratingly feeble for most landlords, owners find overly aggressive rent growth assumptions by both buyers and lenders even more vexing.

"We are very worried about the prospects of rent growth, especially in the office sector," said an investor, while another fretted that "buyers are underwriting recovery whether justified or not”. Another respondent chimed in that rent expectations "have gone from realistic to futuristic”.

However, respondents overwhelmingly agreed that debt remains available for qualified buyers, especially for well-located core assets with reliable rent rolls.

"I feel good about the capital markets in that there is still debt available to do deals," said an investor. Overall, loan-to-value (LTV) ratios for the survey's 35 markets showed an average of 59.4%.

Others, however, believe that financing is more problematic for some office deals, especially where distressed remains an issue. The opposite is true for apartment investors, which has some of the highest LTVs of the quarter.

Average overall capitalisation rates dropped in 26 of 35 markets during the third quarter, and respondents said they expect overall cap rates to either hold steady or decline in most markets over the next six months.

Competition among buyers is strong, with sellers beginning to get the upper hand pricing in certain sub-sectors. About 31.4% of respondents indicated that they believe market conditions favour buyers, down from 58.6% a year ago in 2010 and 80% in 2009. More than a quarter of survey participants view the market as favouring sellers, up from 12.3% in 2010 and 7% in 2009.

In its two-year study, Fitch Ratings analysed the performance of 21,334 commercial properties from 2008 to 2010, which secure its current $270.4bn fixed-rate CMBS portfolio. Just over a third of the portfolio is secured by office, another 33% by retail, 14% multifamily, 7% hotel, 6% industrial/warehouse, and 6% other property types.

Hotels have seen the largest performance declines over the last two years, with NOI dropping 25% between 2008 and 2010, Fitch said. While overall hotel performance may have begun to show signs of improvement with one year of positive growth, many hotel properties, especially limited-service hotels located in secondary and tertiary markets, continued to report a lower NOI in 2010 than in 2008.

"The daily reset of overnight rates make hotel properties the most vulnerable to performance declines," said Fox.

On the other end of the extreme, apartment properties performed better, declining only 1% over the same two-year period, Fitch said. Property managers had been maintaining lower rents and offering concessions in an attempt to bolster occupancy, but some of these concessions are slowly going away.

Office and retail properties, which benefit from longer-term leases, experienced modest NOI declines of 4% and 3%, respectively, from year-end 2008 to 2010.

rdrummer@costar.com

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