Capital Still Flowing into Real Estate

Improvements are in store for all the property types this year, on account of continued improvement in the national economy and a sustained inflow of capital into real estate, according to PNC Real Estate Finance.

Nicholas Buss, a PNC REF researcher, cautions however, in the company's annual real estate forecast, that improving property market fundamentals - such as a rise in leasing traffic, increased uptake of office space and growing business confidence - could be "overshadowed by the direction of real estate capital flows in 2005."

Mr. Buss said, "Real estate today is more liquid than ever before, and by a wide margin. This weight of capital, and the competition it has created, pushed prices up and yields down."

Sales of institutional real estate jumped nearly 50% to $180 billion in 2004 and the commercial real estate debt market grew by 10% to $2.2 trillion as yield-oriented investors continued to be drawn to real estate "in record numbers."

Although he expects that the strong flow of capital to real estate will continue in 2005, Mr. Buss also notes that a combination of rising interest rates and decreased real estate "interest yields" could influence investor behavior.

He observed, "We saw in 1998 that capital can quickly flee a sector, even if that sector is performing well. Although considered to be an unlikely event yet in 2005, real estate must be cautious about potentially finding itself vulnerable if fickle investors chase better returns in another sector."

PNC expects the single-family market to be impacted by rising mortgage rates, in the mid-6% range, which could "take some of the wind out of the sector's sails" and are also likely to reduce sales activity and starts by about 5% to 10%.

In the office sector, stable job growth is expected to translate into increased demand for office space, which will spur new leasing activity. While office vacancy rates are expected to go down to below 15%, this will not be enough to give landlords the upper hand.

The apartment sector could be in for a bumpy ride in 2005. While demand should start to stabilize as job growth continues and mortgage rates move higher, continued construction is likely to overshadow these gains. This means that the national vacancy rate is likely to stay in the 7% range or even go higher.

Also, if the condo market slows, some of the "pricing pressure" is likely to be removed from the apartment sector, which could impact the "capital-driven" construction that is currently going on.

Although the retail sector is likely to face some challenges in 2005, as it is likely that consumers will cut down on spending, the sector is still likely to have an OK year.

PNC expects occupancy in the hotel sector to be in the 62.5%-63% range as demand for hotel rooms continues. This will enable hotels to continue to push up rates. However, rising oil prices, airline bankruptcies and the possibility of terrorist activity pose threats.

SNAPSHOT: Commercial Realty Debt

2003 $2.0 Trillion

2004 $2.2 Trillion

Source: PNC

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