US: Commercial Real Estate Chartbook: Quarter 1
26 MAY 2011
Operating Fundamentals Continue to Improve
The combination of a modest pickup in private-sector job growth and near-record-low commercial construction produced another solid improvement in operating fundamentals during the first quarter. Private-sector employment increased at a 1.9 percent pace during the first quarter, with hiring in business and professional services climbing at a 4.1 percent pace. Stronger job growth helped boost household formations, fueling demand for apartments. Retailers and wholesalers also posted modest gains during the quarter, and office vacancy rates fell for the first time in three years. The improvement in underlying demand has helped pull down vacancy rates and bolster rents. Prices for nondistressed properties have also stabilized.
While improvement is now evident across all product categories and a broad assortment of markets, the recovery remains uneven. Apartments are way out in front. Vacancy rates have now fallen 1.8 percentage points since peaking at 8.0 percent 18 months ago, with the greatest improvement coming in technology centers, such as Austin, San Jose, Seattle, Boston and Raleigh. Effective rents have increased 2.8 percent over this time period, which is spurring new development. Multifamily starts are projected to rise 22.9 percent in 2011 and 28.6 percent in 2012. These gains, however, come off historically low levels of new construction, and apartment markets are still expected to tighten over the coming year.
Improvement in office and industrial markets is somewhat spottier. Nearly every region has seen conditions at least stabilize. Notable bright spots include high-tech centers, such as San Jose, Seattle and Raleigh, along with a number of markets, such as Philadelphia, Pittsburgh and Cleveland, which are home to major capital goods producers. Demand for office and industrial space is also strengthening in major energy markets, such as Houston, Oklahoma City and Denver. Industrial development is another key catalyst, producing stronger job growth in markets such as Greenville, SC, which is home to BMW?s expanding operations, and Charleston, SC, where
Boeing will soon complete a new commercial airliner assembly plant. Markets where the housing bust was more monstrous, including Atlanta, Phoenix, Las Vegas and Tampa, are lagging behind, but still seeing gains in some key submarkets. Demand for retail space is also lagging, particularly in markets where housing took the biggest hits.
Not Out of the Woods Just Yet
While conditions have stabilized, commercial real estate is not out of the woods just yet. There are still billions of dollars of maturing commercial real estate loans that will need to be refinanced over the next five years, many of which have a significant equity gap. Economic growth is also likely to remain relatively sluggish, with real GDP rising in the 2 percent to 3 percent range in 2011 and 2012. Modest economic growth will likely keep absorption on a steadily improving track, but it will also keep lenders and developers unusually cautious. We expect this caution to keep a tight lid on new construction. The lack of building activity should lead to a speedier recovery in operating fundamentals in some of the traditionally oversupplied markets in the Sun Belt, where development typically picks up quickly. Older buildings and second-tier markets could be the biggest beneficiaries from the construction drought.
Aside from a handful of industrial projects and the budding recovery in apartment building, nonresidential construction faces a long road to recovery. We have pushed out our forecast for nonresidential construction spending and now see building activity coming back a bit more slowly. There are simply too few lenders interested in allocating capital for new construction projects. The Japanese earthquake and nuclear disaster will also likely slow construction of nuclear facilities. Two reactors are currently under construction at an existing nuclear facility outside of Augusta, GA. We believe this project will be completed as it is has government support and is located in a region that is unusually comfortable with the nuclear industry. Other nuclear projects that were in various stages of development around the country will likely be stretched out or canceled, however. The increased uncertainty surrounding nuclear power combined with the difficulty in getting new coal plants built is boosting demand for gas-fired plants and alternative energy projects; however, switching construction priorities will take time.
While nonresidential construction is clearly stuck on the slow track, there are still some limited opportunities. Industrial development has been a steady source of growth, particularly in the Sun Belt. Volkswagen just completed construction of a new assembly plant outside Chattanooga, which has spurred a number of suppliers to locate or expand operations in the region. The steel industry is also growing throughout the South, rising up to support the expanding automobile and energy sectors. In addition, lower natural gas prices are helping drive the resurgence in the chemical industry. Growth in the technology sector is also helping support construction, with semiconductor facilities being expanded in Texas, Arizona, California and Oregon. Finally, military base relocations and realignments are creating opportunities in a few markets, although many are off the beaten path in places like Columbus, GA and Fayetteville, NC.
Nonresidential Construction Spending
*Private nonresidential construction spending has been declining for two and a half years, falling by a cumulative 40 percent since topping out in January 2008. Private nonresidential construction outlays, however, are rising modestly in a few subsectors, with improvements in transportation and highway construction spending leading the way.
*Commercial and lodging outlays, which were hardest hit, will likely continue to lag the recovery.
*Prices for construction materials and components increased 1.4 percent in the first quarter.
*Architectural billings, which tend to lead construction by about a year, fell 2.9 points in April to 47.6. The American Institute of Architects cited difficulty in obtaining financing and the winding down of federal stimulus as reasons for the drop.
Commercial Mortgages Outstanding
*Commercial and multifamily mortgage debt outstanding continues to trend lower. Declines, however, are still being driven primarily by outstanding CMBS debt and not multifamily mortgage debt.
*In general, credit remains especially tight for private nonresidential construction, which continues to restrain lending for new commercial real estate projects. As such, borrowers will likely continue to pay down debt and hold off on new projects until operating fundamentals make further improvements.
*Delinquency rates for commercial real estate loans fell 0.72 percentage points in Q4 2010, which is the largest quarterly decline since 1993.
CRE Property Fundamentals
*Operating fundamentals for all major property types have either improved or are showing signs of stabilizing. Gains can largely be attributed to improving economic conditions and near-record-low levels of new construction.
*Cap rates for all property types continued to fall on a 12-month moving average basis. While cap rates are declining, the spread between cap rates and the 10-year Treasury yield is still favorable and remains below the long-run average.
*According to the Moody?s CPPI, commercial real estate prices have decreased 8.5 percent over the past year. Our Structured Products Research Group expects a gradual improvement in prices, but increased distressed sales will likely make price appreciation uneven.
Apartment
*The apartment market continues to outperform, despite the slowdown in Q1 real GDP. In the first quarter of this year, rents increased again, vacancy rates fell further and demand continued to outpace supply by a large margin. Vacancy rates have now fallen 1.8 percentage points to 6.2 percent since peaking at 8.0 percent during late 2009.
*According to the NMHC Quarterly Survey of Apartment Market Conditions, apartment market tightness, which examines vacancies and rents, rose to an all-time high of 90 in April from 78 in January. A reading above 50 suggests the apartment vacancy rate is falling and/or rents are rising.
*Performance in the apartment market continues to be driven by an increased appeal for renting and young people entering the market for the first time.
Office
*Office fundamentals appear to be improving, but any recovery will be slow. Office vacancy rates fell for the first time in three years to 17.5 percent in the first quarter, but remain extremely elevated. As office-using employment continues to increase, we expect occupancy levels to improve. Phoenix, Detroit and Dayton have vacancy rates above 26 percent and will take the longest to recover.
*Completions remained depressed with only 3.9 million sq. ft. delivered. The increase in demand to 5.5 million sq. ft. helped pull down the vacancy rate.
*Office effective rent growth increased for the second consecutive month. Asking rent also increased, but the faster pace of effective rent suggests landlords are less willing to extend concession packages.
Retail
*A modest recovery is finally taking hold in the retail market. In the first quarter of this year, net absorption outpaced supply for the first time since early 2005. Rent growth is showing tentative signs of stabilizing and will likely begin to increase by the second half of this year. The vacancy rate, though still high, appears to have peaked at 10.9 percent, where it has been for the past four quarters.
*Supply, now at a record low, is expected to remain low through the end of the year as most retail developments will be focused on remodeling and repositioning existing centers, as opposed to building new centers.
*Delinquency rates continue to climb in the retail market, increasing 43 bps to 8.2 percent in April.
Industrial
*Operating fundamentals for industrial properties continue to improve. Tenants continue to lease Class A properties first, which are the newer and larger properties. New supply, however, remains low, and operating fundamentals need to improve further before construction picks up at a higher pace.
*Only 2.5 million square feet of space was delivered in the industrial market in the first quarter, which helped pull the vacancy rate down to 11.9 percent.
*Wholesale trade employment has finally turned positive again on a year-over-year basis. The rise in job gains reflects strengthening retail sales, which are boosting demand for distribution centers and warehouses. Supply chain disruptions could slow demand in the coming quarter, however.
Distressed Transactions
*Outstanding distressed volume, which includes foreclosures, bankruptcies and restructured and modified properties, rose to $181.6 billion in the first quarter. Office, apartment and hotel properties made up the largest percentage of distressed volume, but improving fundamentals in apartments, hotels and development assets helped to decrease the overall volume on a year-ago basis.
*Insurance and international banks continued to have the smallest share of total distressed loans and showed the largest percentage of loan workouts.
*Sales out of distress as a share of total activity fell in the first quarter, but lenders continue to illustrate the willingness to resolve troubled loans through sales and liquidations versus modification.
Source: http://7marketspot.com/archives/6629
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