Commercial Property Owners Focus on Preserving Value of Existing Assets
Battered by the U.S. economic recession, the commercial real estate market is struggling to maintain values across all property types and geographic areas, kicking a growing number of investors into survival mode as they painfully watch the value of their existing portfolios decline, according to investors and real estate professionals surveyed as part of the first quarter 2009 PricewaterhouseCoopers Korpacz Real Estate Investor Survey(R).
Real estate investors do not expect a rebound in any of the commercial real estate sectors until well into 2010, according to the survey. In the meantime, property owners are faced with limited financing options, declining tenant demand, rising overall capitalization rates, and deflated confidence. They are looking to protect the value of their existing properties in order to compete and survive in an increasingly challenging environment. To mitigate value loss, landlords are being more proactive about signing tenants to new leases, expansions, and renewal, in some cases offering leasing incentives and lower rental rates. In addition, some are attempting to cut property costs and better position assets in a rapidly growing tenants’ market.
“Tenants are in the driver’s seat, and landlords are in survival mode, trying to preserve revenue streams in one of the harshest ownership environments ever encountered,” said Tim Conlon, partner and U.S. real estate sector leader for PricewaterhouseCoopers. “It will be survival of the fittest going forward, with owners who are able to remain financially strong being better positioned to capitalize on the buying opportunities that are to come.”
Positioning For The Rebound
Although sales have been weak, investors surveyed by PricewaterhouseCoopers expect buying opportunities to emerge in the coming months as commercial loan defaults increase and the number of distressed assets on the market increases. In fact, some investors are preparing for potential acquisitions by boosting their liquidity through de-leveraging, joint venture partnerships and select dispositions of current holdings. However, the bid-ask pricing gap remains wide between buyers and sellers, pricing is opaque because of limited sales activity and financing remains scarce.
Also making acquisitions difficult is the fact that recession conditions in commercial real estate are not expected to ease until 2010 at the earliest for most major property types. One exception to this recovery is the U.S. apartment sector, where demand increased with the rise in foreclosures as many homeowners turned to rental properties as a housing option. As demand for multifamily housing catches up with supply, the apartment sector is expected to emerge from the recession phase of the value cycle ahead of the other sectors, according to the survey
“In recent months, even the most optimistic real estate investors have conceded how challenging today’s economy is for the industry. Their confidence has been battered and it could take years to regain it,” said Susan M. Smith, editor-in-chief of PricewaterhouseCoopers Korpacz Real Estate Investor Survey(R) and a director in the PricewaterhouseCoopers real estate sector services group. “The one certainty they can hold on to is that there will be a recovery, but, until then, they need to determine how to survive under some very tough conditions.”
First Quarter 2009 Sector Highlights
As investment risk has increased, the average overall capitalization rate increased on a quarterly basis for all surveyed markets with the exception of the Washington, DC and Houston office markets. The Pacific Northwest, San Diego and Denver office markets posted the largest quarterly overall cap rate increases in the office sector. Most of the real estate professionals surveyed as part of the Korpacz Real Estate Investor Survey(R) project overall cap rates to increase over the next six months.
Among the significant developments in select sectors during the past quarter:
- Regional malls flatline – Sale transactions have nearly come to a standstill in the national regional mall market, with investors wary of performance and having trouble pricing assets. The average initial-year market rent change assumption dipped to 1.71% this quarter, 92 basis points lower than a year ago and the lowest average ever reported for this market.
- Power centers struggle – With consumers curtailing spending, national power center property owners are struggling to maintain occupancy levels and rental rates. The overall cap rate increased by 41 basis points in the past quarter, to 7.98%, the second straight quarterly increase of at least 40 basis points.
- Office markets crumbling – Demand has weakened for office space, and many traditionally strong markets are seeing vacancy increase. As supply outpaces demand, the average initial-year market rent change rate remains on a downward trend in the office sector, dropping roughly 260 basis points over the past year in the surveyed office markets. Furthermore, property values are expected to drop as much as 30% nationally over the next year in the CBD and suburban office markets.
This quarter’s report also includes a review of the local market outlook for 18 major U.S. office markets including Atlanta, Boston, Charlotte, Chicago, Dallas, Denver, Houston, Los Angeles, Manhattan, Northern Virginia, Pacific Northwest, Philadelphia, Phoenix, San Diego, San Francisco, Southeast Florida, Suburban Maryland, and Washington, DC.