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12 CRE Predictions for 2013

Have We Finally Turned the Corner from the Great Recession?
January 2, 2013
The last few weeks of 2012 revealed a lot about what 2013 could hold in store for the commercial real estate sector, and it appears to be shaping up to look a lot different (i.e., better) than the last couple of years.

Deal flow increased notably after the presidential election as the uncertainty ended over what policies would shape the U.S. economy for the next four years and as the housing market recovery seemed to take hold.

Also, the fiscal cliff proved to be a political hallucination - a compelling hallucination, but a cliff that nevertheless that could be pushed off in time rather than us being pushed over the ledge.


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So, with the prospect of another Washington-induced recession seeming more imaginary than authentic, it also appears that 2013 will be a year when the CRE markets see a return to more normalcy.

Following are a dozen outlooks for 2013 encapsulated from forecasts offered by respected industry participants and observers.

Investment Market Will Be Up 20%


The commercial real estate industry's measured and steady recovery is expected to bolster further growth in the United States, with the greatest demand amidst the multifamily, office and industrial sectors, according to respondents of Jones Lang LaSalle's 2013 Cross Sector Survey.

While unemployment and Eurozone fears remain top of mind and an uncertain United States political picture is introducing more cautious action, 56% of industry respondents to the Cross Sector Survey expect their investment activity to rise by as much as 20% in 2013, compared with last year.

"This year, we're likely to close 2012 with only a 10% improvement over last year in investment trades for all sectors, excluding hotels," said Jay Koster, president of Jones Lang LaSalle's Americas Capital Markets. "While the growth rate has slowed, the investment transaction market is still markedly above the 2009 floor, and transactions are still improving in the face of significant economic headwinds. The record-low Treasuries are also giving the transaction market a boost as an attractive lending market should continue to pave the way for a strong fourth quarter and an increase in investment transactions in 2013."

Investors still prefer multifamily as their investment property of preference for 2013, with 43% of respondents ranking multifamily as the most appealing product type followed by 27% who chose office as their secondary preference. Industrial ranked in third at 14%, retail fourth with 12%, and hotels with 4% of respondents ranking it as the fifth most appealing product type.

Earliest Buyers Will Be the Sellers in 2013


Blackstone Group LP, which has been a major buyer of commercial real estate since the economic collapse in 2007, will shift to being a major seller in 2013, harvesting some of the gains from its 2007 and 2008 investments, Tony James, president and COO of Blackstone, told Goldman Sachs Financial Services Conference attendees last month.

In fact, the shift has already begun. Blackstone did about $1.8 billion in dispositions in 2011 and will do about $3.7 billion this year.

Blackstone believes it’s an opportune time to be disposing of stabilized properties right now because cap rates and interest rates are so low.

"Cap rates are really, really low because so many investors in the world say, 'I'm tired of taking risk, I want to go buy hard assets,'" James said. "I’m not saying we’re calling the top here. It’s just that what we do is we buy it when it is usually a distressed property or distressed owner. We fix it and we sell it. That’s all we do. It’s a very simple formula. Once we fix it, we don’t play the market, we push it out there. We’re converting property from distressed real estate to core real estate. We sell into the core buyers because that is where you get these very low cap rates."

More Sellers Will Emerge, But May Be Discouraged


"2013 will likely begin with a large pool of sellers pondering whether or not they are indeed still sellers depending on the current tax environment," said Geoffrey Faulkner, managing partner of NNNet Advisors. "(We) expect to see more sellers motivated only by the ability to complete a successful 1031 exchange. These sellers will continue to face the challenge of limited quality supply on the up-leg of their exchanges, which in turn, will likely hinder and altogether discourage many sellers. Artificially low interest rates will continue to push caps lower on high quality properties, while cap rates on lower-quality properties that are difficult to finance will continue to rise. Overall, with interest rates likely to hover close to where they are today, we expect transaction levels for 2013 to mirror those of 2012."

Strongest Markets Will Be on the West Coast


Commercial real estate will be a big beneficiary of an improving U.S. economy in 2013, according to the respected Kiplinger Letter.

Among the major predictions for the coming year, Kiplinger sees Boston, Minneapolis, Dallas, Oklahoma City, Denver, San Francisco and San Jose, Portland, OR and Seattle as being among the the strongest markets for office space.

Demand for warehouses is heating up in Seattle, Denver, San Diego, L.A., Houston and Philadelphia, while the much-battered market for retail space is brightening, with rents headed a whisker higher on average in 2013, after bottoming out this year.

From an investor perspective, apartment buildings - where vacancy rates continue to slide and rents will climb higher next year - retain the most appeal. Standout markets include Orlando, Houston, Phoenix, Denver, Salt Lake City and the San Francisco Bay area.

Shift to Secondary and Tertiary Markets Will Continue


As the real estate industry continues to recover from its multi-year slump, prospects for 2013 look stronger, particularly so for real estate investment trusts looking to raise capital by going public and a pickup in secondary and tertiary market activity. The real estate banking team at the investment firm Robert W. Baird is looking to 2013 with an eye to the following major investment themes.

As values for multi-family, industrial, and office developments rise in and around major cities, investor interest is likely to move to the secondary and tertiary markets where pricing is more favorable and demand is strong. These include markets such as Charlotte and Raleigh-Durham in North Carolina, San Antonio in Texas, and Seattle.

Interest in mergers and acquisitions will remain muted, with the possible exception of lodging. "Many of the public REITs are trading above NAV [net asset value], so they can acquire companies in transactions that are immediately accretive," said Steve Goldberg at Baird. "At this point in the cycle, those companies that have been able to raise equity in the public markets have a significant cost of capital advantage."

After Slow Star, Pace Will Accelerate Through 2013 and into 2014


2013 is expected to be a turning point for the economy and the commercial real estate industry, according to Cushman & Wakefield’s Global Economic Pulse Forecast. While 2013 will get off to a slow start coming as it does at the end of the slowest economic recovery on record, however, C&W beleieves the stage has been set for a significant turn-up in market sentiment by year end, setting the stage for a strong global rebound in 2014 and beyond.

"We believe in 2013 there will be more clarity to political and economic challenges plaguing the global economy," said Glenn Rufrano, president and CEO of Cushman & Wakefield. "As we see solutions evolve, confidence should return, demand will accelerate and lead to a much healthier economic climate."

Greater Acceptance of Slow Growth


Others believe that slow growth is here to stay. According to findings of the PwC Real Estate Investor Survey, investors in the office sector are showing a greater acceptance for slower growth and less apprehension about moving further out on the risk spectrum. Although core trophy assets remain the preferred target of both domestic and international investors, aggressive pricing and improved fundamentals have resulted in certain investors looking to buy either core in strong secondary markets or less-than-core in primary markets.

"The commercial real estate industry continues to show its investment durability as assets command attractive spreads over fixed-income investments and offer more stability than stocks, while most property sectors continue to post occupancy gains and rental rate growth," said Mitch Roschelle, partner, U.S. real estate advisory practice leader, PwC.

"Foreign investors are particularly bullish on U.S. commercial real estate as they look for stable investments during uncertain times abroad. In 2013, Survey respondents expect to see an uptick in sales activity as property owners cull portfolios to take advantage of the low cap rate environment. And as investment capital continues its trend of matriculating beyond just apartments, cap rates are expected to compress across the entire asset class."

Recovery Will Require New Technology To Keep Pace


The U.S. commercial real estate (CRE) recovery, although slow, is visibly improved in fundamentals, capital availability, asset pricing and transactions, according to Deloitte’s Commercial Real Estate Outlook. While the global economic slowdown continues to hinder development, CRE players are finding growth in alternative mechanisms such as technological innovation.

"Overall, we are seeing recovery in commercial real estate activity; however, the pace of recovery is likely to be more modest across several property types until the broader economy picks up," said Bob O’Brien, vice chairman and Deloitte’s real estate sector leader. "Sustainability is gaining a lot of traction in the real estate industry, and there is renewed interest in foreign investment, especially in emerging markets. In addition, investors from emerging countries like China are looking to the U.S. for stable investments."

"It is critical for CRE players to aggressively adopt technological innovation, like cloud computing, analytics and social media, to spur growth and maintain their competitive edge," O’Brien continued.

Cloud computing drives operational efficiency, mobility improves the customer experience and social media helps CRE firms gather pertinent data around consumer behaviors. For an industry that has traditionally been slow to adopt new technologies, it is more important than ever that CRE players re-strategize and adapt to maintain their competitive edge, Deloitte argues.

CRE players need to address new business challenges and simultaneously improve operational performance and effectively manage enterprise risk. Analytics can help CRE players address these needs by integrating capabilities in data management, statistics, technology, automation and governance into a potent catalyst for making better and faster decisions. In the long-term, the level of analytics implemented will likely be a key differentiator in assessment of tenant mix and retention strategies across real estate sub-sectors.

2013 Will Be Good for Equity REITs


Equity REITs will continue to have solid access to capital, improved liquidity and improving fixed charge coverage and property-level fundamentals

Absent fallout from the fiscal cliff, Fitch Ratings said it expects modest growth in GDP in 2013, which will contribute to slightly positive property-level fundamentals. Retail, industrial and central business district office REITs should have modestly positive same-store NOI (SSNOI) growth. The suburban office sector will continue to face challenges in maintaining SSNOI.

Fitch said it expects issuers will continue to have liberal access to historically low-cost debt. Leverage, long a concern for Fitch with respect to equity REITs is likely to remain elevated. Fitch said expects REITs to fully move away from reducing debt and instead use proceeds from follow-on common equity offerings for development and other growth opportunities.

Apart from negotiated off-market transactions, Fitch said expects REIT acquisition volumes in 2013 to remain relatively unchanged from 2012 levels. Health care REITs may buck this trend and continue to pursue property, portfolio, and entity acquisition opportunities.

CMBS Performance Could Fall Off


"As we head into a new year, we see value in CMBS but do not anticipate the sector will deliver the outsized returns achieved in 2012," said Marielle Jan de Beur, managing director and head of CMBS and real estate research for Wells Fargo Securities.

"We anticipate the market will overcome the regulatory hurdles facing the new issue market and forecast $50 billion of private-label issuance and $65 billion of agency CMBS issuance in 2013," Jan de Beur said.

"The 30+ day delinquency rate for fixed-rate conduit CMBS is currently at 9.38%," she said. "As we look ahead to 2013, we only expect a modest decline to around 9% by year-end 2013."

"The large amount of liquidations in 2012 has helped to decrease the balance of loans in special servicing, but even with the reduction, there is still a sizable loan pipeline that needs resolution. As a result, we do not expect liquidations to let up much in 2013. (Rather,) we expect to see a substantial decline in the number of extensions in 2013 as the most of the maturing loans will be from the pre-2005 vintages."

The securities analyst is expecting to see continued improvement across all property sectors through 2013 with the apartment sector expected to outperform the other property types.

"Minimal new supply should allow modest demand to continue keeping downward pressure on office, retail and industrial sector vacancy rates," said Jan de Beur said. "Hotel occupancy gains likely will slow in 2013, limiting increases in property revenues. Based on the revenue outlook for the core property types, we forecast property prices will increase 3% on average."

Bricks and Mortar Retails To Focus ON "Sure Thing"


The impact of e-commerce on bricks-and-mortar retailers will continue to expand. This long-term trend will gradually redefine shopping center tenant mixes (look for more dining and entertainment uses) and retail development, according to the Chainlinks Retail Advisors 2013 retail outlook.

Retailer expansion in 2013 will be about “the sure thing;” urban over suburban, Class A and B over Class C and locations with greater population densities and higher income demographics still winning out most of the time.

Retail categories expected to expand in 2013 include: New smaller grocery concepts and niche players ranging from discount to luxury and ethnic to organic; Fast food and fast casual lead the way in restaurants, but growth expected across the full spectrum -- fitness/health/ spa concepts, drug stores, dollar stores, thrift stores, automotive service, discounters, off-price apparel, pet supplies, sporting goods, hobby stores/arts & crafts, wireless stores (limited growth driven mostly by a few new concepts)and some banking/check cashing/financial services growth. Restaurants will account for about 40% of all the new tenancy in the marketplace in 2013 (unit counts, not square footage).

Contracting retail categories in 2013 include: Traditional larger format grocery stores - especially unionized smaller or regional chains; Video rental and video game stores; Bookstores; Do-it-yourself home stores (though these will rally by 2014); Stationary/gift shops; Office supplies will continue to shift more to e-commerce; Shipping/postal stores; Certain casual dining concepts (the old and stale will lose out to new and fresh).

Housing-related retailers ranging from home goods to furniture to do-it-yourself home improvement stores will rally by 2014 thanks to the return of the housing market.

Retail development in 2013 will still dominated by urban redevelopment projects, outlet malls and the occasional long- planned regional mall going forward. There will only be limited suburban development throughout 2013, though this will be slowly changing as now home starts rise over the course of the year.

Speaking of which...

Slow and Steady Housing Recovery


Upward trends in recent months among a number of housing indicators point to a slow and steady growth in the nation’s housing market in 2013, but several challenges remain, according to David Crowe, chief economist for the National Association of Home Builders (NAHB).

"Consistent, positive reports on housing starts, permits, prices, new-home sales and builder confidence in recent months provide further confirmation that a gradual but steady housing recovery is underway across much of the nation," Crowe said. "However, stubbornly tight lending standards for home buyers and builders, inaccurate appraisals and proposals by policymakers to tamper with the mortgage interest deduction could dampen future housing demand."

Stating there is no consistent national trend, Crowe noted the housing recovery is local but spreading.

"We are transitioning from a very low demand level, where most people hold themselves out of the marketplace, to a case where supply will start being the problem," he said. "As we begin to build more homes to address that supply, the new home stock will be a much more important element of the recovery."


Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published late each Wednesday.


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