Commercial real estate investors reveal a sense of hopefulness and improved sentiment with regard to the industry as the U.S. economy shows some encouraging signs of improvement, according to the first-quarter 2010 findings of PricewaterhouseCoopers' (PwC) Korpacz Real Estate Investor Survey.
The report notes that investors find it easier to envision a commercial real estate market recovery today than at any point during the past 24 months. At the same time, however, investors acknowledge that challenges and concerns still exist.Â
According to the survey, overall capitalization rates – a key measure of expectations of property income and value – have started to stabilize and even slightly decline in certain markets and for quality assets.Â This trend may help to stabilize values since weak fundamentals are still a drag on value appreciation, PwC says.Â Over the next six months, survey participants forecast overall cap rates to hold steady in 19 of the survey's 30 markets. Last quarter, just two markets had such a forecast from survey participants.
‘Following the onset of the recession and the credit crisis, underlying fundamentals were deteriorating and overall cap rates were expanding simultaneously and quickly, causing values to plummet,’ says Susan Smith, director, real estate advisory practice, PricewaterhouseCoopers, and editor-in-chief of the survey.Â ‘The worst seems to be over, according to survey participants, as investors suggest that the bottom is near, if not here, particularly for better-positioned markets and assets.’
In the survey's national and regional apartment markets, the low end of the range for overall cap rates decreased 75 basis points (bps) this quarter to 5%, pushing the averages down 18 and 50 bps, respectively, due mainly to the numerous bidders showing up to buy quality assets in good markets. At the same time, average marketing times are down in these two survey markets, further signaling restored confidence among many investors.
The report finds that while 2010 is expected to be a slow year for sales activity by historical comparison, there could be marked improvement from 2009, as banks appear more willing to lend although underwriting remains very conservative and more equity is needed to secure debt.
"Many investors in our survey still anticipate incurable deleveraging issues on the part of both lenders and owners to provide opportunities to acquire quality assets at below-peak pricing, and there's strong competition among buyers for such deals, as investors indicate increasing activity with both the number of bids and good offers,’ Smith adds.
According to the report, looming debt maturities remain a top-of-mind issue among surveyed investors, who believe the out-of-balance loans coming due over the near term will present major hurdles for owners and lenders.
‘The industry keeps looking to lending institutions and special servicers of commercial mortgage-backed securities to provide forced sales, but some investors surveyed cite that more distressed selling will likely come from borrowers, who are more comfortable with where the market is now and will accept a loss in order to move on,’ Smith says.
While occupancy and rental rates have deteriorated significantly during the past 24 months, surveyed investors anticipate vacancy rates to continue to increase in the coming year, though as steeply as the prior year.Â In addition, they foresee rental rates continuing to decline in most markets, but to lesser degrees, as property visits and tenant interest show slight improvements across the country.Â
Consequently, many survey investors continue to use low, and in certain markets negative, market rent change rate assumptions in the initial years of cash flow analyses. While the majority of the 30 surveyed markets report negative average initial-year market rent change rates this quarter, the expected declines are milder in comparison to the prior quarter.Â Â Â
As weak tenant demand lingers, investors surveyed indicate an increasing need to offer prospective tenants free rent during lease negotiations. Overall, just over 91% of surveyed investors reported the use of free rent. Last year, this survey figure was 84%.
Office markets where survey investors report the highest levels of free rent over an average seven-year term include Phoenix (up to 24 months), Atlanta and Chicago (up to 18 months), and Dallas (up to 15 months).Â Lower levels are noted for San Diego (up to 6 months) and Los Angeles and Denver (up to 7 months).
Surveyed investors project that the apartment sector will continue to lead the recovery as value losses have been almost fully recognized, and some multifamily assets are actually showing slight value increases. The warehouse sector remains weak, according to survey participants, due to an overall lack of demand for goods, while the office and retail sectors continue to struggle as both economy and employment challenges persist.