Real Estate Values Continue Upward Movement

NEW YORK CITY-During the past 12 months, class A commercial real estate continued to appreciate–logging a 4.2% increase, according to the National Real Estate Index published by Global Real Analytics, LLC. This rise follows an upward trajectory that began in 2001, according to Dan O’Connor, managing director, global forecasting/real estate research at GRA. “Low financing costs are certainly a major contributing factor. We believe, however, that there may have been a long-term or ‘secular’ shift in required returns for real estate, a consequence of the perceived stability of the asset class and its ability to produce significant income. The latter attribute is attractive both because of demographics–most developed countries have large populations at or nearing retirement–and because many investors were chastened by the high-tech stock debacle.”In addition to the increase, the index reports that the range in value appreciation across property sectors narrowed in the fourth quarter of 2004. However, anchored retail shopping centers still ranked No. 1 with an increase of 6.6% for the year and a 1.4% for the fourth quarter. The apartment sector came in second with a 4.4% increase for the year and 1.2% for the quarter. Rounding out the property sectors, industrial registered a 3.7% for the year and 1.1% increase for the quarter; CBD office registered a 3.3% increase for the year and a .5% increase for the quarter; and suburban office registered a .9% increase for the year and a .4% increase for the quarter. (For more information, please go to Market Source .)”Retail remained the leader in 2004 and, significantly, was the only major property category that exhibited healthy rental performance as well,” O’Connor says. “Toward the end of the year, however, retail did not outperform by as great a margin. This slowing can be attributed, in our view, to the fact that virtually all of the factors that contributed to robust household consumption in recent years–reduced federal income taxes, lower mortgage refinancing and generally cheap money–are not as pronounced as before.”Apartments continue to benefit from high investor demand. Apartment cap rates have fallen to an all-time low and high-quality assets with “condo maps” are selling for as little as three or four times income, he explains. However, O’Connor adds the valuations and performance may not be on the same page. “Our view, perhaps not shared by all analysts, is that apartment valuations have gotten too far out of sync with underlying performance. While the sector, which has many talented operators, showed some signs of stabilization in the latter half of 2004, households are still buying homes, as evidenced by the near 70% national home ownership rate and public policy in this nation [more so than in most developed countries] is highly skewed towards ownership. In our view, healthy employment growth is an absolute prerequisite for a sustainable recovery in this sector.”As for the CBD office markets, the analyst sees the uptick in valuations as “an important discernable trend,” he says. “Though underlying office performance varies greatly across the US, investors continued to ‘pay up’ for quality assets in what they perceive to be ‘core’ downtown office markets.” Favored markets include Midtown Manhattan, Washington, DC, Boston, Chicago, San Francisco, Seattle and, more recently, Los Angeles, Downtown Manhattan and San Diego. In addition to the National Valuation Index, GRA also publishes the Local Value Index. Florida–with Orlando at No. 1, Miami at No. 3 and West Palm Beach at No. 10–registers the most cities in the Top 10. Other strong regions in 2004 were the Mid-Atlantic and Southern California. O’Connor says Florida benefited from healthy job growth and a rebounding leisure sector. In addition, the Mid-Atlantic markets share a reliance on the federal government and major factors in Southern California’s strong valuation included transshipment, biotechnology, entertainment and population growth, he explains.On the other side of the spectrum, the Midwest and Texas rank among the bottom markets. O’Connor attributes mediocre job growth and very high office vacancy in several Midwest markets to the region’s low ranking. As for Texas, he points to an oversupply, mediocre job growth and a “still too active construction sector in some locales” as contributing factors to three cities landing the Bottom 10 list.As for 2005, GRA looks to a better balance of real estate valuations. “We are hopeful that operating performance rebounds sufficiently such that real estate valuations and underlying market fundamentals strike a better balance. For that to occur, however, there must be sustained employment growth,” O’Connor concludes. “We believe that it is unrealistic to expect cap rates, which are already at all-time lows in a number of property categories, to fall much further, especially in an economic environment with an upward rate bias. Even if that job growth does not materialize, however, we would not expect a dramatic decline in property values, but merely a leveling off of recent growth rates.”