Commercial Real Estate Mending Amid Ongoing Economic, Political Uncertainty

Q3 Roundtable Survey Shows Fundamentals, Property Values Improving, But Vulnerable to
Rising Interest Rates, Economic Headwinds, Looming Policy Decisions

WASHINGTON, Aug. 2, 2013 /PRNewswire-USNewswire/ -- Commercial real estate markets continue their gradual, uneven recovery — with investment capital beginning to flow beyond "gateway" and multifamily markets — yet industry executives remain wary about the future amid lackluster job creation; uncertainty over monetary, fiscal and terrorism insurance policy; and rising interest rates, which could lead to deceleration in the pace of property value gains, The Real Estate Roundtable's Q3 Sentiment Survey showed today.

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The latest survey continues the basically flat trajectory of the past several quarters, with the "Current Conditions" index remaining at 71, the "Overall" index rising 1 point since the previous quarter (to 70), and the "Future Conditions" index rising 1 point (from the 67 points registered in the past two quarters). Although today's figures certainly are in positive territory (being above 50), they also illustrate an erosion of confidence among industry participants as the recovery has dragged on. The Future Index, for example, hit almost 80 in Q2-2010 but slipped below the Current Index around the time of the 2011 debt ceiling crisis (falling to 75), and now stands at only 68, several points below the Current Conditions reading.

"Today's survey indicates a commercial real estate sector and national economy stuck on a plateau of recovery — certainly improved since the worst days of the recession, but not moving forward in any robust way," said Roundtable President and CEO Jeffrey DeBoer. "The slow pace of macroeconomic recovery is directly tied to the 'flatlining' of expectations in our industry, which is why The Roundtable continues to press for an array of federal policies aimed at unleashing investment and job creation," he added.

These include proposals to spur foreign equity investment in U.S. real estate and infrastructure — cited by President Obama in his economic speech this week and reintroduced Wednesday by Reps. Kevin Brady (R-TX) and Joseph Crowley (D-NY). The Roundtable also strongly supports legislation to encourage energy retrofits of commercial buildings; pro-growth tax reform that preserves real estate's role as an economic driver; and balanced immigration reform. [See July 23 real estate letter to U.S. Senators on tax reform] Keeping the U.S. terrorism risk insurance program ("TRIA") in place beyond 2014 is also critical to protecting future credit availability for commercial real estate, and borrowers' ability to refinance maturing debt.

At a meeting of U.S. Senators and industry representatives yesterday, DeBoer underscored the vast policy uncertainty that continues to undermine job creation. "The level of uncertainty today continues to be high. Interest rates, health care, tax policy — all are huge question marks for businesses looking to create jobs and expand," he said.

On the positive side, a majority of respondents in the Q3 survey continued to view real estate market conditions as having improved at least somewhat over the past year (77% in the current survey, compared to 75% in Q2), and there was a slight uptick (from 62% to 65%) in the number of participants anticipating at least "somewhat better" conditions within the next 12 months.

Q3 survey participants also noted increased planning and construction in asset classes outside the multifamily (apartment) segment — as well as increased investor interest outside "red hot" cities such as New York, San Francisco, Dallas and Houston. At the same time, there was a strong undercurrent of caution in the respondents' anecdotal comments.  Thus, while prospects are improving in second-tier cities — particularly for "the best assets" and for value-added deals — the bifurcation that has characterized the industry's recovery over the past four years largely continues.

As one respondent said, "Capital is moving up the risk curve in the most popular markets and migrating to the best assets in second tier cities, but for the majority of assets the outlook remains uncertain at best."  Echoing these nuanced views of market conditions, another commenter said, "General conditions are good but not terrific. People are still incredibly cautious with their growth plans; everyone is planning on growth, but they are hesitant to take a leap of faith in this economy."  Yet another said the "torturous recovery . . . is continuing."

On the subject of interest rates, the current survey revealed a similar split in views between current and future conditions.  For now, strong capital availability and optimism about better growth have helped to maintain or even improve property values.  Looking ahead, however, numerous respondents in the Q3 survey expressed concern about interest rates and their potential to slow the recovery of asset values, which fell as much as 50% in some markets during the Great Recession (wiping out owner equity and leaving many properties "underwater").

Although the Fed is expected to maintain its highly accommodative monetary policy for the foreseeable future — signaling this week that "tapering" of the "QE3" program is now less imminent — the risk is that interest rates could begin to rise before property owners' net operating incomes (NOI) have caught up with increasing job creation. Artificially low interest rates are also contributing to artificially high asset prices in some areas, so that a sudden increase in interest rates could wreak havoc with property values and pricing.

The Roundtable's Sentiment Index is the industry's most comprehensive measure of leading real estate executives' confidence in financial and real estate markets.  The survey, conducted by FPL Advisory Group, captures the perspectives of senior real estate executives, including CEOs, presidents, board members, and other executives from a broad set of industry sectors including owners and asset managers, financial services firms and operators. A PDF of the entire survey report is available online at www.rer.org.

SOURCE Real Estate Roundtable