Commercial Real Estate Still Attracting Investment

Commercial real estate properties continued to attract investor interest in the second quarter, according to a report from PricewaterhouseCoopers, fueled by improving fundamental factors, interest rates and a lack of alternative investment options.

"Aggressive buyers, high prices, low-cap rates and virtually limitless sources of capital continue to characterize the investment side of the commercial real estate industry," according to Peter Korpacz, director, PricewaterhouseCoopers' global strategic real estate research group.

"Pent-up demand for real estate from all-cash buyers, particularly pension funds, is also expected to materialize once rising interest rates begin to push some leveraged buyers to the sidelines. The bottom line is an elongated pricing peak similar to the one that rental rates experienced in the late 1990s. Although this elongated pricing peak has been with us for almost three years, few investors foresee an end to it anytime soon," he noted.

Mr. Korpacz expects that increases in capitalization rates - or the required rates of return on real estate investments - are likely to lag behind interest rate hikes.

The report singles out self-storage property as one sector that has seen "particularly strong interest" from institutional as well as individual investors. This is a sector that is seen as maturing and one that has a good outlook for the future.

In the retail market, February 2005 saw the lowest monthly sales volume for retail properties in about two years, according to the report. According to one survey respondent, "Most of the better properties have sold and what is available now just doesn't appeal to the majority of top players." Power center retail properties continue to see a high level of interest, along with national strip shopping center properties.

The downtown, or central business district, office market continued to improve steadily in the second quarter, with gains in overall absorption and declines in overall vacancies.

Still, there are individual downtown markets with increases in vacancies, such as Chicago, Atlanta, Dallas, Philadelphia and Phoenix.

Office capitalization rates dropped to 8% in the second quarter, the lowest recorded by the report for the office market. PWC expects it could decline even further given the lack of alternative investments and the availability of capital for real estate investments.

The suburban office market saw overall vacancy rates continue to decline, especially in Los Angeles and Northern Virginia. PWC reports that about $10 billion of suburban office properties were sold in the first quarter of the year, a 70% increase over the first quarter of 2004, thanks to increased investor interest in these properties.

Multifamily properties continue to be hot, with the hottest markets including Northern Virginia, New York, Las Vegas, Phoenix, San Francisco and Miami. Atlanta and San Diego are also sought-after markets.

Apartment property sales totaled $15.6 billion for the first quarter, nearly equal to the record set in the last quarter of 2004, according to PWC.

Condominium conversions, representing 25% of the total market sales volume, are seen as a driving force behind the increased sales prices and depressed overall cap rates, which went down to 6.52% in the second quarter.

In the warehouse sector, vacancy is improving, spurred by improving industrial performance. The first quarter's 9.2% vacancy rate for the sector is the lowest in two and a half years, the PWC report says, aided by increased demand and restraints on new construction.

Warehouse markets that performed "extremely well" in the first quarter include California's Inland Empire, Dallas and Philadelphia. And Northern New Jersey, Los Angeles, Chicago, Atlanta and San Diego also saw "robust sales activity."

The flex/R&D sector also saw increases in demand and leasing activity, especially in Florida and Southern California markets.

In addition to small-scale users, demand in this market has also come from users requiring 25,000 to 50,000 square feet.

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