Deloitte LLP’s commercial real estate outlook for 2012 includes a cryptic subtitle: “A potential pause in recovery momentum.” There are, in fact, some market indicators trending downward. However, for ULI members spread across the commercial real estate landscape, the forecast is decidedly more mixed for the coming year, depending on the market sector.  

On the positive side, commercial real estate is benefiting from favorable fundamentals and absorption dynamics, with record-low construction activity driving better rent and vacancy trends, particularly in the apartment and lodging sectors. This is attracting greater foreign investment, and overall transaction volumes continue to climb. Meanwhile, there’s still a significant amount of unused reserve financial capital on the sidelines, waiting for investment opportunities. So capital availability and improved fundamentals bode well for 2012.

On the flip side, though, economic growth has softened, real estate loan delinquencies remain high, credit markets have turned volatile, and loan underwriting standards continue to tighten. These are the factors that threaten the real estate industry’s momentum. In short, according to Deloitte’s report, the commercial real estate market “appears to be on a gradual but uneven path to recovery.”

Deloitte’s report highlighted commercial real estate’s top ten issue trends for 2012. Here’s the list:

Trend

Indicator

Deloitte’s 2012 Outlook

1. Foreign investment

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The U.S. commercial real estate market continues to draw foreign investor interest as the economy slowly recovers and investors capitalize on attractive opportunities. Foreign investment as a percentage of total investment in U.S. commercial real estate rose to 12.3 percent in July 2011, compared with 8.4 percent at the same time in 2010. According to the most recent survey of the Association of Foreign Investors in Real Estate (AFIRE), more than 60 percent of respondents identified the United States as offering the best potential for capital appreciation.

2. Soft economy

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Continued slow macroeconomic growth will potentially stem commercial real estate expansion. Successive quarters of positive gross domestic product (GDP) growth remain below expectations, with Deloitte Research forecasting 2011 to end with 2.5 percent GDP growth, which is below 2010’s level. Subdued consumer spending, reduced federal government spending, and a weak housing market will potentially delay a full-fledged commercial real estate recovery.

3. Favorable fundamentals

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Commercial real estate fundamentals are benefiting from favorable absorption-completion dynamics. Record-low construction and property development are resulting in better-than-expected absorption, so there is a gradual recovery in overall rent and vacancies. But the trend varies across sectors. The apartment and lodging sectors have the most favorable rent and vacancy trends, while retail and industrial appear to be the slowest to recover.

4. Maturing debt

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An uptick in loan restructurings plus improved property fundamentals has decreased commercial real estate loan delinquencies. However, at least $1.8 trillion of commercial real estate debt will mature between 2011 and 2015. The high level of maturing debt remains a significant barrier to recovery. Debt incurred at the top of the market is now coming due at a time when economic uncertainty has resurfaced.

5. Revival of CMBS

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Commercial mortgage–backed securities (CMBS) were the most affected financing source during the recession, as issuance dropped to near zero in 2009. A turnaround began last year, and 2011 issuance is expected to nearly triple 2010’s level, but this recovery has potentially stalled due to credit-market volatility, which is expected to adversely affect the overall pipeline. The reemergence of the CMBS market could have the greatest impact on the availability of debt capital going forward.

6. Robust REITs

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The real estate investment trust (REIT) recovery began much earlier than that of the underlying commercial real estate fundamentals, primarily due to the opening of capital markets. REITs continue to outperform many traditional asset classes, and fundraising by public REITs was up 66.5 percent this year through July. REITs’ growth prospects are now heavily dependent on acquisitions and generating increasing rental income, but REITs are well positioned going forward due to these market dynamics and improvements in property fundamentals.

7. Ample dry powder

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According to a Preqin survey conducted in July, 72 percent of alternative investment consultants were expected to significantly or slightly increase recommended capital commitments to real estate in 2011. That was a vast improvement from February’s 45 percent. In the United States, dry powder—or unused reserve financial capital—has increased modestly this year to nearly $86 billion, highlighting the substantial capital readily available for real estate investments. A significant amount of capital raised has yet to be deployed.

8. Distressed transactions

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A bright spot in the commercial real estate recovery process has been transaction activity, driven by REITs and distressed deals. This year, U.S. transaction volumes are on pace to nearly double 2010’s level, led by office properties. Distressed assets are close to a peak, but with an estimated $183 billion in troubled assets, transaction opportunities still exist. So growth in transaction activity is expected to continue with increased capital availability.

9. Prolonged foreclosures

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Some key measures of the real estate industry’s health have yet to recover, particularly in housing. Foreclosures fell this year to their lowest quarterly level since 2007, but mortgage defaults are expected to trend upward because of sustained levels of high unemployment. Analysts believe a rising backlog of foreclosed inventory and government initiatives to delay foreclosure actions may prolong the difficult housing situation. For a residential real estate recovery to begin, it is likely that the inventory of foreclosed homes and those in the pipeline will need to be cleared.

10. Stricter underwriting

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Underwriting standards for residential real estate loans remain stringent. According to an annual survey conducted by the Office of the Comptroller of Currency, residential real estate loans—including construction—experienced the most tightening in underwriting standards during the 2011 survey period. Of 48 banks surveyed, 40 percent continued to tighten standards and another 52 percent kept their previously tightened standards unchanged. Recovery in the residential mortgage market will be highly dependent on how mortgage regulations evolve and how the market acts in response.

Source: Deloitte’s Commercial Real Estate Outlook.