“Rate Risk” Tops Real Estate Issues for 2013

Interest and capitalization rate risk, shifting demand for health care, and the resurgence of capital markets are the top three risks to real estate for 2013, according to the Chicago-based Counselors of Real Estate (CRE).

Howard C. Gelbtuch, the 2013 chairman of CRE, shared his group’s consensus top-ten risks at the National Association of Real Estate Editors annual conference in Atlanta in June.

“We’re selling everything that’s not nailed down,” said Gelbtuch. “And if we’re not selling it, we’re refinancing.” He said there is $2 trillion in debt maturing over the next five years without a lot of margin for error if interest rates were to rise more than they already have.

The following are CRE’s top-ten risks to real estate for 2013:

10. Retail malaise and repositioning. Rapid ongoing growth of internet retailing has reduced overall demand for physical stores, influencing the amount of bricks-and-mortar retail space tenants need. But Gelbtuch expects the retail center outside of the core cities to bounce back, saying, “Don’t underestimate the social experience of going to the mall.” He also sees “tremendous value in the portfolios of the dowdiest retailers. The dowdier, the better. We spent more time last year looking at Kmart and Sears. This year, it’s JCPenney.”

9. Impact of technology on office space. Technology combined with growing acceptance of unconventional workspace models are reducing demand for traditional office space.

8. Global real estate growth and risk. Investors looking for value are moving on from China, Russia, India, and Brazil to South Korea, Nigeria, Bangladesh, and Vietnam, says Gelbtuch. Office projects are growing in places like Mexico City, Rio de Janeiro, and São Paulo.

7. Increased U.S. natural gas mining and reserves. New technologies that enable access to North American natural gas reserves are creating an economic boom in the United States. Gelbtuch said that North Dakota now has more oil reserves than California.

6. Echo boomer housing demand. Gelbtuch expects the suburbs to fight back, reversing to some degree the trend among millennials and baby boomers to opt for more expensive, urban housing options.

5. Implications of climate change/weather on coastal properties. While residential properties have largely recovered from Superstorm Sandy, Gelbtuch said some restaurants and other businesses in Brooklyn and Manhattan have still not reopened.

4. Event risks, such as terrorist attacks and weather catastrophes. Gelbtuch cited the Boston Marathon bombings and the tornado damage in Oklahoma as recent instances of disruptive events that are largely unexpected.

3. Capital markets resurgence. Gelbtuch said things are “starting to get scary” with looser underwriting and higher loan-to-value ratios.

2. Health care. Demand for medical services and facilities is expected to increase because of the changing health care needs of aging baby boomers and expanded health insurance coverage created by the federal Patient Protection and Affordable Care Act. Gelbtuch said that recent graduates—already saddled with a weak job market and large student loan debts—may soon face the prospect of caring for their aging baby boomer parents.

1. Low interest and capitalization rate risks. Real estate has dramatically benefited from low interest rates, which cannot go much lower. Cap rates continue to decline in primary, secondary, and tertiary U.S. markets, but are especially low in global gateway markets, posing risk to equity values if cap rates should rise significantly. If interest rates rise as the economy improves in 2013, it could lead to cap rate decompression. Investors must be aware and adjust their property strategy accordingly.