Investors Expect 2004 To Be A Transition Period
By: Al Heavens

Real estate investors are expecting 2004 to be a transition period as markets move toward a weak recovery tempered by a continued loss of jobs overseas, limited job creation here at home and continued budget shortfalls in all levels of government.

That, at least, is how the annual Emerging Trends in Real Estate report looks at it. The report, developed by the Urban Land Institute (ULI) and PricewaterhouseCoopers LLP, is based on surveys and interviews with more than 350 of the industry's leading authorities.

So far, returns continue to belie weak market fundamentals, including high vacancy rates, falling rents, resurgent concessions, rising property taxes and higher operating expenses, the report says. However, if interest rates rise too quickly before job growth drives up leasing activity, property values could fall even as the economic recovery gathers steam.

"No one expects a sudden rebound," according to Emerging Trends. "Rents will be flat in most sectors, down more for office. Income returns carry the day, appreciation will be negligible and many office markets will experience value dips or worse. Retail returns will moderate, warehouses, apartments and hotels show slight improvements. Capital flows remain plentiful, but will diminish as an improving stock market draws attention away from real estate. Defaults and delinquencies will increase modestly, and office markets will be the most troubled."

Says one interviewee, "Real estate is the tail of the dog. We're not the drag on the economy like the early nineties. We're being dragged by it this time."

Says another, "It's hard to have much near-term conviction."

Emerging Trends found that the joblessness is the interviewees' leading concern.

"Real estate markets need corporations to expand their U.S. workforces to fill empty office space, increase production and distribution benefiting warehouses, and step up business travel to lift hotels," the report said. “Additional wage earners, cashing bigger paychecks, will rent more apartments and spend more in malls. That hasn't been happening."

Contributing to the lack of U.S. jobs is continued job outsourcing of corporations, including more knowledge-based positions as well as those in manufacturing. "It was one thing to move a back office to the suburbs in the eighties or send a call center to Sioux Falls in the nineties; it's quite another to move an accounting operation to Banglahor," says an interviewee.

Respondents also expressed unease over geopolitical risk and its ability to undermine a real estate rebound in America. While fears of terrorism have faded somewhat, some lasting impacts effecting building occupancy include a lingering reluctance of tenants to locate in the top floors of the tallest buildings, continued corporate dispersion, some increases in security and safety expenses, a growing concern over mall vulnerability, and curbed business travel.

Technology was cited as another factor effecting building occupancy. While advances have improved efficiency and productivity, such services as satellite systems, telecommunications improvements, secure Internet shopping, Internet travel and lodging reservations and just-in-time distribution systems are cutting the need for space.

In its "markets to watch" category, only Washington, D.C. received unwavering endorsement from respondents as a still-promising investment market, followed by New York and the Southern California region from San Diego to Los Angeles.

Other cities cited -- either because their real estate markets are improving or because they are bargain bins -- include Chicago, San Francisco, Seattle, Philadelphia, Phoenix, Houston, Denver, Atlanta and Dallas.

Some respondents expressed growing interest in smaller second- and third-tier cities, particularly those with state capitals or universities, such as Birmingham, Ala.; Tallahassee, Fla.; Columbia, S.C.; and Boise, Idaho.

Concerns over sprawl-related issues, such as traffic congestion and inadequate infrastructure, dampened interest in larger second-tier cities such as Orlando, Fla., Nashville, Tenn., and Charlotte, N.C.

In terms of overall real estate capital availability, most survey respondents believe investment funds will remain plentiful, but that some capital likely will be diverted to the stock market in 2004. Indeed, 52 percent of the participants predict stocks will outperform real estate; yet 95 percent believe real estate returns will exceed those for bonds.

"For 2004, developers have two choices -- go to the beach or play golf," comments an interviewer.

The few exceptions:

  • For-sale housing in infill locations, which scored high interest due to downtown migration by singles and empty nesters, as well as tighter growth controls in outlying areas.

  • Low- and moderate-income apartments in close-in areas to help fill the need for affordable housing.

  • Brownfield restoration, now considered less risky than in the past, and which offers good prospects for town center housing.

  • Master-planned communities with open space and pedestrian-friendly design.

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