Approximately 1,200 people crowded into one of the ballrooms at last week’s ULI Fall Meeting in Chicago to hear the kick-off presentation for Emerging Trends in Real Estate 2014. If you missed it, check your local district council’s calendar as the road show is scheduled to tour nationwide.
Now in its 35th year, Emerging Trends is a joint venture of PricewaterhouseCoopers and ULI and provides an outlook on investment, development, finance, the capital markets, property sectors and markets, and issues affecting the real estate industry. This year, more than 1,000 persons participated in the Emerging Trends one-on-one interview or on-line survey process.
The following is a brief summary of the presentation:
- Where are we? “In the beginning of the ‘middle innings,’ in the midst of the recovery from the recovery.”
- Economic fundamentals are starting to improve . . . slowly.
- Financial engineering is being replaced by property engineering.
- Interest rates are going up—it’s the “when” that is so baffling.
- Survey participants continue to rank private direct real estate investment as having the best investment prospects.
- Average market scores increased year over year and are above precrisis levels.
- Industrial/distribution properties had the highest property scores; retail properties had the lowest.
- Issues of greatest importance included jobs, interest rates, increases in construction costs, and vacancy rates.
- Headwinds: Weakness in the Eurozone economy; slowing in China’s economic growth; uncertainty in direction of governmental policy; and increases in interest rates.
- Tailwinds: improving single-family industry; increasing corporate profits; and job growth in high real estate utilization industries such as technology.
- Industry profitability expected to continue to increase.
- Dependence on cap rate compression to drive value is being replaced by an emphasis on asset management.
- Opportunities to develop property are finally appearing in sectors other than multifamily.
- Value-added investment ranked highest in terms of investment strategy; distressed properties and distressed debt ranked last.
- Equity sources of capital: foreign investors; institutional investors; and private funds ranked first, second, and third.
- Commercial mortgage–backed securities (CMBS) were the highest-ranking lending source, followed by commercial banks and insurance companies.
- Overall, survey participants anticipate a moderate oversupply of equity capital in 2014, with debt capital basically in balance.
- Underwriting standards are expected to be rigorous.
- The Emerging Trends buy-sell-hold barometer reflects a lack of any clear market direction; the best properties are too expensive to buy, but where could you reinvest your capital anyway? Many owners will continue to settle into a holding pattern and wait to see what develops during the year.
- Both equity investors and lenders are widening their search for business to include secondary markets and niche property types.
- San Francisco is the top-ranked market.
Monday’s Numbers
The Trepp survey for the period ending November 1, 2013, showed spreads basically unchanged during the most recent survey period. Absent an “event” of some kind, it is likely that asking spreads will move in a narrow band through yearend 2013.
Asking Spreads over U.S. Ten-Year Treasury Bonds in Basis Points | ||||||||
12/31/09 | 12/31/10 | 12/31/11 | 12/31/12 | 10/11/13 | 10/18/13 | 10/25/13 | 11/1/13 | |
| Office | 342 | 214 | 210 | 210 | 175 | 181 | 173 | 181 |
| Retail | 326 | 207 | 207 | 192 | 166 | 178 | 168 | 174 |
| Multifamily | 318 | 188 | 202 | 182 | 163 | 168 | 163 | 159 |
| Industrial | 333 | 201 | 205 | 191 | 166 | 171 | 166 | 162 |
| Average spread | 330 | 203 | 205 | 194 | 168 | 175 | 168 | 169 |
| 10-Year Treasury | 3.83% | 3.29% | .88% | 1.64% | 2.70% | 2.60% | 2.70% | 2.60% |
The most recent Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads dated September 9, 2013, showed spreads coming in 5 basis points during the survey period.
We expect the balance of the year to play out as follows: with interest rates expected to increase in the near future, borrowers will focus on closing committed deals as soon as possible so as to lock in today’s cheap financing. On the other hand, you will see lenders trying to dig in their heels and not get locked into subpar returns for up to a ten-year holding. All-in costs should range in the 4.50 to 5.00 percent area.
Ten-Year Fixed Rate Commercial Real Estate Mortgages (as of September 13, 2013) | |||
Property | Maximum | Class A | Class B |
| Multifamily (agency) | 75–80% | T +205 | T +215 |
| Multifamily (nonagency) | 70–75% | T +215 | T +220 |
| Anchored retail | 70–75% | T +220 | T +235 |
| Strip center | 65–70% | T +240 | T +255 |
| Distribution/warehouse | 65–70% | T +220 | T +235 |
| R&D/flex/industrial | 65–70% | T +235 | T +255 |
| Office | 65–75% | T +210 | T +230 |
| Full-service hotel | 55–65% | T +270 | T +295 |
| Debt-service-coverage ratio assumed to be greater than 1.35 to 1. | |||
Year-to-Date Public Equity Capital Markets
DJIA (1): +20.28%
S & P 500 (2): +24.15%
NASDAQ (3): +29.80%
Russell 2000 (4):+29.51%
Morgan Stanley U.S. REIT (5): +0.01%
(1) Dow Jones Industrial Average; (2) Standard & Poor’s 500 Stock Index; (3) NASD Composite Index; (4) Small-capitalization segment of U.S. equity universe; (5) Morgan Stanley REIT Index.
U.S. Treasury Yields | |||
12/31/11 | 12/31/12 | 11/8/13 | |
| 3-Month | 0.01% | 0.08% | 0.06% |
| 6-Month | 0.06% | 0.12% | 0.09% |
| 2-Year | 0.24% | 0.27% | 0.32% |
| 5-Year | 0.83% | 0.76% | 1.42% |
| 7-Year | 1.35% | 1.25% | 2.12% |
| 10-Year | 1.88% | 1.86% | 2.77% |
Key Rates (in Percentages) | ||
Current | One year prior | |
| Federal funds rate | 0.08 | 0.17 |
| Federal Reserve target rate | 0.25 | 0.25 |
| Prime rate | 3.25 | 3.25 |
| U.S. unemployment rate | 7.30 | 8.50 |
| 1-Month LIBOR | 0.17 | 0.21 |
| 3-Month LIBOR | 0.24 | 0.31 |
