Despite a still-struggling U.S. economy, ill credit markets, deteriorating property fundamentals, and precipitous declines in commercial real estate values, most equity investors have remained on the sidelines waiting to capitalize on forced sales and more motivated selling on the part of distressed owners, according to the 2009 third quarter findings of PricewaterhouseCoopers' Korpacz Real Estate Investor Survey, released this week. The report finds that investors anticipate near-term defaults combined with looming due dates on CMBS (commercial mortgage backed securities) maturities to jump-start distressed buying opportunities during the next year.
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Buyers Wait Patiently For Opportunities
So far, the de-leveraging of the commercial real estate industry has disappointed many investors who have been waiting patiently to acquire quality, stable assets at distressed pricing.
“Investors seem surprised at the lack of quality buying opportunities given the problems in the financial markets and the continued weakening of the industry's fundamentals,” said Susan Smith, director, real estate advisory practice, PricewaterhouseCoopers, and editor-in-chief of the Survey. “Some investors sense that near-term defaults with commercial banks will allow them to acquire quality assets at steep discounts, as banks may no longer be able to continue to ‘pretend and extend’ troubled loans and would be forced to place assets up for sale.”
While some investors are looking to the $153 billion of CMBS loans due in 2012 to spur buying opportunities, commercial banks account for a much greater percentage of the total looming debt and could provide distressed sales sooner than 2012.
“It appears many banks are playing a ‘timing game’ attempting to replenish their capital reserves in anticipation that the economic recovery will bolster property values. This may be a risky proposition given that commercial real estate's performance often lags what happens in the economy and in this game, the banks can ultimately lose,” added Susan Smith.
Surveyed investors believe the massive amount of leverage used to fuel the buying frenzy during the peak of the cycle in 2006-2007 will greatly increase the number of commercial properties for sale primarily due to owners who are unable to cover their debt service obligations and incapable of refinancing.
If such buying opportunities do come to fruition, the next challenge for investors will likely be asset pricing. The report cites that a bid-ask pricing gap still exists across all property sectors and geographies. In addition, the unraveling of the debt markets appears to be keeping offering bids from buyers low. The industry's current challenges are also keeping some investors focused on asset management and value preservation rather than on new acquisitions.
Key Sector and Regional Highlights
Overall, surveyed investors anticipate further deterioration in the underlying fundamentals of the commercial real estate industry through the remainder of 2009 and into 2010. Investor pessimism in the industry's near-term performance is evidenced by the use of much lower market rent change assumptions in cash flow analyses. All of the 28 surveyed markets reported a decline in the average initial-year market rent change. For certain property sectors and geographic areas, the anticipated declines in market rent are steep. In the national suburban office market, surveyed investors expect market rent to drop as much as 20 percent in the coming months. Other sharp declines are anticipated for the following markets: national CBD office (as much as 10 percent), national power center and national warehouse (as much as 10 percent), and national regional mall (as much as 5 percent).
For the Survey's office markets, investors expect the biggest near-term market rent declines in both Manhattan and San Francisco (as much as 20 percent) and Phoenix (as much as 15 percent). Boston, Chicago, Denver, Los Angeles and San Diego each report expected declines of as much as 10 percent. In contrast, market rent is expected to remain relatively flat for the office markets of Dallas, Northern Virginia and Pacific Northwest.
In the U.S. lodging industry, the effects of cautious spending by businesses and consumers is expected to continue to negatively impact occupancy and revenue. The Survey projects overall lodging demand to decrease 5.3 percent in 2009. Furthermore, occupancy levels and average daily rates (ADR) in the second half of 2009 are expected to remain below last year'slevels.
Little Relief in Sight
The PricewaterhouseCoopers survey finds that the majority of the commercial real estate industry is expected to remain in recession through 2011. While an industry-wide recovery is not expected to begin until 2012, the pace of the recovery will vary for each property sector, as well as across individual geographies. In the industrial and office sectors, a more pronounced recovery is expected to materialize in 2011, but is not expected to dominate these sectors until 2012. In the retail sector, the recession phase of the cycle is expected to linger through 2011, giving way to a slight recovery in 2012. In contrast, the U.S. multifamily sector is expected to lead the industry out of the recession as its recovery starts to take hold in 2010 and continues through 2012. .
Individual office markets highlighted by the Survey as expected to recover ahead of the industry include Washington, DC, San Francisco, Philadelphia and Long Island. Office regions that may suffer longer from Survey indications include Sacramento, Denver, Cleveland, and Fort Lauderdale. In the retail sector, the Survey notes an earlier entrance into recovery is expected for only a few regions, including Oakland-East Bay, Fort Lauderdale, Nashville, and Houston. On the other hand, several multifamily regions show expected persistent strength, such as Portland, Los Angeles, and Minneapolis. And in the warehouse sector, West Coast cities are expected to lead the recovery charge, including the cities of Oakland, Portland, Salt Lake City, and Orange County.
Information about subscribing to PricewaterhouseCoopers' Korpacz Real Estate Investor Survey can be found at http://www.pwc.com/.