First Quarter 2012 Real Estate Investment Outlook

A Special Research Report

First Quarter 2012 Real Estate Investmet Outlook

Investor confidence hits a high note 

The economic recovery and greater access to capital are fueling property sales in 2012.

Investor Confidence Climbs to New High The NREI/Marcus & Millichap Investor Sentiment Index shows that investor confidence has not only rebounded from its fourth-quarter dip, but it has leaped forward to reach a new peak. The Investor Sentiment Index climbed to 166 at the end of first quarter—the highest level since the index began in 2004. Investor confidence regained some of the ground that was lost in fourth-quarter when investor confidence stumbled and the index dipped to 152. Sentiment also surpassed the previous high point in the survey of 164 that was recorded in second quarter 2011. National Real Estate Investor and Marcus & Millichap Real Estate Investment Services have conducted research on investor expectations and views over the past eight years as part of a commercial real estate industry forecast. The Investor Sentiment Index is a measure of survey responses related to key factors including anticipated changes in property values, as well as plans to increase or decrease total real estate holdings over the next 12 months.

Figure 1. Overall Real Estate Outlook

P ositive news in recent months on everything from jobs data and consumer spending to rising occupancies appears to be striking a chord with commercial real estate investors. The latest NREI/Marcus & Millichap Investor Sentiment Survey shows that investor confidence has once again surged forward. The Investor Sentiment Index hit a high of 166—the highest level since the index began in 2004.

Investor confidence regained some of the ground that was lost in the fourth quarter when the index dipped to 152. Sentiment also surpassed the previous high point in the survey of 164 that was recorded in the second quarter of 2011 [Figure 1]. Specifically, a jump in confidence in apartment and industrial sectors helped to bolster overall sentiment. Both apartment and industrial sentiment rose four points over the previous high-water marks achieved in the second quarter last year. The sentiment on apartments increased from 166 to 170, while on industrial properties it improved from 140 to 144. 

“The index has been an accurate indicator of economic and market direction,” says Hessam Nadji, a senior vice presidentand managing director at Marcus & Millichap. “The minor dip in the second half of last year and Q1 rise in sentiment are very much aligned with the improved economic data that we have been seeing over the last few months.”

That growing confidence is further reinforced by investor plans to expand real estate holdings. More than half of the survey’s respondents (58 percent) plan to increase their commercial real estate investment in the next 12 months. That is consistent with fourth quarter survey results when 60 percent of respondents said they intended to grow their real estate portfolios. An additional 25 percent expect investments to remain the same, while only 4 percent expect their real estate holdings to decrease over the next year. Among respondents who expect to add real estate investments, an average 21.5 percent increase in portfolio size is predicted. 

More investment for 2012 

Transaction volume did improve in 2011. The $211.3 billion in commercial property transactions that occurred last year represented a 55 percent increase compared to 2010. Although that volume is still about half of the level that was achieved at the peak of the market in 2007, it is consistent with 2004 transaction volume when sales reached $201.2 billion, according to New York-based Real Capital Analytics. Commercial real estate is expected to capture more capital investment in 2012, in large part because of its competitive yields and improving fundamentals across all property types. Half of the respondents believe that property values have bottomed out, while 52 percent agree that occupancies have bottomed out. Despite a soaring stock market where the Dow Jones Industrial Average has eclipsed 13,000, respondents agree that commercial real estate offers favorable returns. The majority of respondents (70 percent) somewhat or strongly agree that commercial real estate offers favorable returns relative to other investment classes. In addition, most respondents would rather have their money in direct real estate investment as opposed to REIT stocks. Only about one in three respondents (36 percent) agree that now is a good time to invest in public REIT stocks.

Another factor that will fuel buyer demand in the coming year is continued improvement in the ability to access capital. “Interest rates are still incredibly low, and if you compound that with additional financing sources, that really does translate to a further increase in transaction velocity,” says Nadji. Although 25 percent of respondents indicate that the availability of financing has not changed in the past six months, 57 percent said that it is somewhat or much more widely available than six months ago. Only 6 percent said that capital was less available today, while 11 percent either had not attempted to borrow money in the last six months or had no answer. [Figure 2]. 

Figure 2. Loan Terms and Availability As a commercial real estate borrower, what is your assessment of the availability of financing today versus six months ago?

Apartments remain top pick 

Investors continue to see apartments as a safer bet in a fragile economic recovery. Overall, 61 percent of apartment investors believe now is the time to buy more and nearly three out of four respondents, 72 percent, believe that apartment values will increase in the coming year.

That confidence has certainly been supported by the category’s strong performance. Apartments continue to outperform every other property type in terms of occupancies, absorption and rent growth. Apartment vacancies dropped 140 basis points in 2011 to reach 5.2 percent and are expected to improve further to 4.8 percent this year, according to Marcus & Millichap. Effective rents increased 4 percent to average $980, and effective rents are forecast to jump 4.8 percent this year to $1,027.

“By now, we would have expected to see more of a contrarian view toward investing in retail, or industrial or even office, because the economy is clearly improving, Capital flows into these sectors has been dominated by too high quality, low-risk assets,” says Al Pontius, senior vice president and National Director of Marcus & Millichap’s Commercial Properties Group. Industry data supports the fact that fundamentals have stabilized and started to improve in the office, retail and industrial markets, and there is virtually no new construction under way. “Investor reaction towards those other property types is somewhat delayed. I think that speaks to the fear factor in the marketplace that something still could go wrong with the economy,” he adds.

Investors do have concerns, however, when it comes to macroeconomic and political conditions. Top concerns continue to be the state of the U.S. economy at 83 percent, large federal and state budget deficits at 59 percent, high unemployment and underemployment at 55 percent, potential increases in taxes at 55 percent, political uncertainty at 51 percent and availability of financing at 50 percent. “Commercial real estate is improving and investor sentiment is improving along with it. But, there is still a fairly large fear factor in the market— mainly about the economy,” says Nadji

Investors remain skeptical of an effective resolution to the European debt crisis. Only 1 percent of respondents expect the recent measures taken by the EU to stabilize the debt crisis to be a permanent solution. One in four respondents believes the measures will provide a temporary solution for stability that will last through 2012. Among the naysayers, 40 percent expect another potential financial crisis related to Europe, while 19 percent predict that Europe will come up with another solution. 

Economic performance is expected to be volatile, but positive overall in 2012. Two-thirds of respondents are predicting that the better-than-expected U.S. economic performance over the last 90 days will prevail over volatility to deliver a slightly or much better economic performance this year. 

Retail regains confidence

Stronger retail sales data coupled with signs that retail real estate is performing better than expected has fortified investor confidence for this property type. 

Retail saw the biggest improvement in investor confidence compared to fourth quarter with the Investment Sentiment Index for retail spiking 15 points from 119 to 134—nearly recapturing the peak level it had reached in second quarter 2011 at 135.

Retail property fundamentals do show a better than expected recovery in occupancies. According to Marcus & Millichap, retail vacancies ended 2011 at 9.7 percent and are projected to improve further to 9.2 percent in 2012. “Retail is in a constant state of reinvention,” says Bill Rose, National Director of Marcus & Millichap’s National Retail Group. “Better than expected retail sales and bottoming of the housing market bode well despite high gas prices,” he adds.

Evidence that the retail market is stabilizing has produced a moderate improvement in investor confidence. Half of retail owners believe now is the time to buy more, which is slightly ahead of the 43 percent who felt the same in fourth quarter, and comparable to the 50 percent who believe the time was right to buy more in both the fourth quarter 2010 and second quarter 2011 surveys. Half of respondents expect no change in property values in the coming year, while 42 percent expect an increase and only 8 percent expect a decline in values. Overall, retail investors expect value to rise an average of 2.8 percent.

Industrial stock rises

Survey respondents expressed a more positive view of industrial properties. Nearly half of industrial owners, 49 percent, believe now is the time to buy more, which is up slightly compared to the 43 percent that held a similar view in 4Q [Figure 3]. In addition, owners expressed their strongest confidence yet that industrial values are poised to rise in the coming 12 months. Forty-nine percent said values will most likely rise in the coming year, which is higher than the 34 percent who held that opinion in the fourth quarter and even slightly higher than the 48 percent who held that view in 2Q 2011.

Industrial is perhaps the second-most popular safety play after apartments. The United States has added more than 220,000 manufacturing jobs in the past year. “So, there is a warehousing and manufacturing recovery that is fueling demand for industrial space,” adds Nadji. In 2011, the industrial vacancy rate declined 70 basis points to 11.9 percent and is expected to drop a further 90 basis points this year to reach 11 percent, according to Marcus & Millichap.

Another factor that bodes well for industrial is that at this point, new construction remains fairly muted with just 28.4 million sq. ft. of new completions in 2011. Marcus & Millichap expects completions to rise to about 45 million sq. ft. this year. But that’s still low compared to historical norms. For example, in 2008, the sector delivered 150 million sq. ft.

Figure 3. Investor Perception of Property Types In your view, is now the time to buy, hold or sell each of the following property types? Percentages reflect only the opinions of respondents invested in each property type

Offices hold steady

The outlook for office properties remains relatively neutral. Overall, 46 percent of office investors believe now is the time to hold, while 43 percent of office investors believe now is the time to buy more and 9 percent believe it is time to sell. That sentiment has changed very little over the last two years. Confidence that values will rise in the coming year ticked slightly higher. More than one-third of office owners, 39 percent, expect values to increase 12 months from now compared to 46 percent who expect values to remain the same and 15 percent who anticipate a further decline.

What is notable is that the 39 percent— although still a distinct minority—represents the highest level of confidence in more than three years. “You would think that net absorption for office would be improving quicker, because we added roughly 660,000 business and service jobs in the last 12 months,” says Pontius. However, companies still have excess space and the amount of square footage per employee is still shrinking. 

Although office vacancies have started to drop, there is still a large amount of surplus space that needs to be absorbed. In 2011, the office vacancy rate improved 30 basis points to 17.3 percent, according to Marcus & Millichap. Office vacancies are expected to drop a further 70 basis points this year to 16.6 percent by year-end. Companies that have leases expiring are still very conservative. They are looking to cut costs, not add costs. “That is why the positive economic numbers on job creation is not translating to absorption yet. I think the real turnaround in office will come at the back end of 2012, and really start to show in 2013,” says Nadji.

Hotels lose momentum

Hotel owners are not as bullish as they were a year ago. Nearly half of hotel owners, 49 percent, believe now is the time tobuy more compared to second quarter 2011 when 68 percent thought it was an opportune time to buy. 

That drop in sentiment is likely a sign that confidence in hotels has leveled off, and even dropped as consumers continue to tighten their belts in lieu of the slow economic recovery and higher gas prices.

The hotel sector is showing improvement in its fundamentals. For the week of February 26 through March 3, year-over-year occupancy rates rose 2.3 percent to average 59.9 percent, average daily rate (ADR) increased 3.5 percent to $102.77, and revenue per available room (RevPAR) was up 5.8 percent to $61.56, according to data from Hendersonville, Tenn.- based STR Global

Although fewer hotel owners expect hotel values to rise in the coming year, it is still a significant number. Half of hotel owners, 51 percent, believe that property values will rise in the coming year compared to 2Q 2011 when 63 percent expected that values would increase. Those that do anticipate a further increase in values in the coming year expect an improvement of 4.4 percent; not as high as the 6.9 percent jump that was forecast in second quarter 2011, but a healthy improvement all the same

Overall, the sharp rise in investment sentiment bodes well for the continued commercial real estate market recovery. “What is also notable is that investment sentiment did weather a strong jolt when the U.S. debt downgrade occurred in August of 2011,” says Nadji. “Now that we are six months beyond the debt downgrade, all of those fears that we were going into a double dip recession and the sky was falling were not validated at all by commercial real estate investor sentiment—and they turned out to be right again.”