Survey Finds Concern about Real Estate Prices

An investor survey conducted by PricewaterhouseCoopers found that while investors continue to pursue well-leased properties in strong markets, they are concerned that industry fundamentals seem to be weakening.

Peter Korpacz, director of the company's global strategic real estate research practice, said even optimistic investors "worry that the longer the downturn persists, the greater the likelihood of widespread income losses. Rental rates will fall, vacancy rates will rise, and overall cap rates will fail to offset the resulting drop in income that will occur."

But in the meantime, commercial real estate remains hot. The survey found that institutional investors, foreign investors, and real estate investment trusts continued to buy property in the fourth quarter of 2002, with prices rising sharply as a result of the competition.

And favorable financing terms are one reason demand remains strong. Attractive financing has allowed small, private investors to compete head-to-head against major institutions and REITs, the survey said.

Particularly, regional malls and well-leased office buildings in key markets were caught in bidding wars, the survey found.

The PricewaterhouseCoopers survey found that apartments continue to prevail as the most sought after property type. Readily available and inexpensive debt has enabled many borrowers to remain assertive as buyers.

Most of the recent acquisitions by REITs have been in the retail sector. By comparison, both institutional and foreign investors have been active buyers of office properties.

Foreign acquisitions of U.S. commercial real estate nearly doubled in 2002. Over 80% of foreign investment has been in the office sector, primarily Central Business District towers. The average sales price paid by a foreign investor is almost $60 million, nearly double the market average.

Specifically, 45% of foreign capital has been invested in Manhattan, while another 20% has gone to Chicago this year.

Competition among buyers for commercial real estate has raised sale prices and lowered overall cap rates for properties that offer "credit and term" financing, the report said. However, only the best performing office properties in attractive markets are of interest to investors.

Assets with a strong tenant base and limited short-term leasing risk are of greatest value. As a result, despite rising vacancy rates, capital continues to flow into the downtown office markets.

Regional malls also saw strong trading in the first nine months of last year, especially in the Midwest, according to the survey. A large share of the deal flow has been completed in smaller metro areas rather than in larger metropolitan markets.

The sectors attracting the least interest from investors are community centers, power centers, suburban office buildings and research and development property.

Nationally, the suburban office market continues to suffer from a glut of available space. That is allowing tenants to negotiate lower rents, tenant improvement allowances, and large amounts of free rent, according to the survey.

80% of survey participants indicate that concessions are prevalent throughout the national suburban office market, up from 65% who said so a year earlier.

Favorable financing has attracted more competitors to the market. In Southern California, local buyers account for about 40% of apartment transactions, with REITs and institutions representing about 30% each.

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