ULI Real Estate Business Barometer -- August 2011

Summary

This month’s Barometer data (which cover activity through the end of July) is a study in disparity. Whether this turns out to be the calm before the storm remains to be seen. Second-quarter GDP growth was alarmingly weak, and job growth was just not enough; capital markets indicators fared well; commercial real estate fundamentals improved primarily for apartments and hotels; and the weak housing data stay weak. Still, compared to one year ago, 61 percent of key indicators in the Barometer are better and 39 percent are worse. But the recent budget deal, credit rating downgrade, and stock market declines that occurred in early August are not reflected in any of this data and will likely lead to significant changes in the real estate sector over the coming month.

Note: More commentary and data can be found throughout the tabs and in the accompanying tables.

In economic news, the second-quarter 2011 GDP growth depicted a fragile economy growing at less than one-half its historic quarterly average; this followed a stunning downgrade of the first-quarter GDP to almost no growth. Private sector employment growth in July was a welcome improvement over June’s low numbers, but state and local government layoffs continue; net job growth over the past year has restored only a fraction of the jobs lost since early 2008. Consumer confidence and retail sales were up, though it is likely that next month’s numbers will reflect early August’s economic events.

In real estate capital markets, commercial property prices in the Moodys and CoStar indexes were finally turning upward, reversing their months-long downward trend; transaction volumes increased substantially, almost entirely due to Blackstone’s purchase of the retail assets of Centro Properties Group. Returns were positive for both NCREIF in the second-quarter and NAREIT in July. On the other hand, CMBS issuance was down and CMBS delinquencies were up.

In commercial property markets, second-quarter apartment rental rates and hotel RevPAR show both quarterly and year-over-year improvements, as do apartment vacancy and hotel occupancy rates; completions of both apartments and hotel rooms remain substantially below their historical averages. Second-quarter office, retail, and industrial rental rates have decreased from the same quarter one year ago, while vacancy rates in these sectors have marginally improved.

In the housing market, new foreclosure activity increased in June, though it is lower than a year ago; lenders’ procedural delays are extending the period during which distressed properties could affect the housing market. Sales of new single-family homes remain at historically low levels and declined again, while prices continue to edge up and are within view of their pre-recession peak. Sales of existing single-family homes are above the long-term monthly average but remained unchanged this month; while existing single-family home prices appear to be on the upswing, prices remain significantly off their pre-recession peak. Despite these weaknesses, multifamily permits and starts of all types of housing were up in June and pending home sales increased.

Economy

On the surface, the economic data in this month’s Barometer provided a few positive signals—an increase in consumer confidence and retail sales and stronger private sector employment growth this month than last. But these employment figures are still not strong—at this rate it would take almost five years for growth to replace all jobs lost since losses kicked in early 2008—and state and local government layoffs continue. Further, the second-quarter GDP growth was feeble and there is little comfort that it is higher than the paltry GDP growth of the first quarter. S&P returns were negative in July.

A net increase of 117,000 jobs in July was caused by an increase of 154,000 private sector jobs (primarily in health care, retail trade, manufacturing, professional and technical services, leisure and hospitality, and mining) and the loss of 37,000 government jobs (from state and local governments). A total of 1.26 million jobs have been created since July 2010—only 18 percent of the net total of 6.81 million lost since February 2008. The unemployment rate in July inched down to 9.1 percent after three straight months of slight increases.

The advance estimate of second-quarter 2011 GDP growth is 1.3 percent, less than half the long-term quarterly average growth of 2.8 percent. This follows the revision (based on newly available and more comprehensive source data) of first-quarter GDP down to a meager 0.4 percent. Factors contributing to the second-quarter growth were exports, nonresidential fixed investment, private inventory investment, and federal government spending, which was partially offset by a decrease in state and local government spending. Imports, which are a subtraction in the GDP, increased. And personal consumption of durable goods declined.

The Consumer Confidence Index rose 3 percent from 57.6 in June to 59.5 in July. It is now at 68 percent of January 2008’s level of 87.3. Retail sales grew in June after a slight dip in May had ended ten straight months of growth. The increase in June was concentrated in department stores, building materials, and motor vehicles, but declines were also seen—in gasoline, furniture, sporting goods/hobby/book stores, and food services. Actual retail sales volume—$387.8 billion—is up 8.1 percent over one year ago but exceeds the pre-recession peak of $378.4 billion (in November 2007) by only 2.5 percent.

Inflation, as measured by the Consumer Price Index, was –0.2 percent in June, clearly off from the long-term monthly average (since 1970) of 0.4 percent and down from May’s inflation rate of 0.2 percent. June’s decline was due primarily to a sharp decline in gasoline prices, as well as more moderate declines in fuel oil and household energy costs; most other categories continued to rise. For the past 12 months, the CPI has risen 3.6 percent.

June’s S&P 500 returns were negative for the third-straight month, at –2.03 percent, after eight straight months of positive activity, and year-over-year returns stood at 19.7 percent, still above the long-term 12-month average of 10.6 percent.

Real Estate Capital Markets

Commercial property prices in the Moodys and CoStar indexes reversed their downward trend and transaction volume increased substantially for the second-straight month, almost entirely due to a single acquisition of a 585-property retail portfolio. Returns were positive for both NCREIF in the second-quarter and NAREIT in July. The CMBS market did not have as good a month, with issuance down and delinquencies higher.

Capitalization rates, as reported by Real Capital Analytics, were fairly stable at 7.09 percent in June. Cap rates remain above the 6.40 percent of September 2007, but are below the historical norm of 7.6 percent (since 2001). Capitalization rates reported by NCREIF were also fairly stable at 6.06 percent in the second quarter. NCREIF’s cap rates remain above the 5.4 percent of the first quarter of 2008 but are below the historical norm of 7.6 percent (since 1978).

Commercial property sales volumes

jumped to $23.4 billion in June from $13.9 billion in May, according to Real Capital Analytics, and are now substantially above the historical monthly average (since 2001). This is the second-straight month with a significant increase over the previous month. In June, almost the entire total increase was attributable to Blackstone’s purchase of the retail assets of Centro Properties Group. According to Real Capital Analytics, the most active sales markets in the past 12 months are, in descending order, Manhattan, Los Angeles, Chicago, Dallas, San Francisco, the Virginia suburbs of Washington, D.C., Washington, D.C., Boston, Atlanta, and Phoenix. Over $4.92 billion in transactions has been recorded in each of these cities since July 1, 2010.

The Moody’s/REAL Commercial Property Price Index rose by a strong 6.3 percent in May after five straight months of decline had led to the lowest value (in April) since the index’s inception in 2001. (This is a same-property index based on all U.S. transactions over $2.5 million and reported monthly as a three-month moving average, with a two-month lag.) Values are now off 46 percent from their peak in October 2007; the index is down 11.2 percent from a year ago.

The Investment Grade Index of the CoStar Commercial Repeat-Sale Indices increased 4.4 percent in May after four straight months of decline. (These indices are based on a repeat-sales methodology that tracks transactions over $100,000 and includes land sales, with a two-month lag.) Values are now down 38 percent from the peak value in June 2007 and up 5.0 percent from a year ago. The General Grade Index of the CoStar Commercial Repeat-Sale Indices increased 0.9 percent after declines in six of the past seven months; it is now down 35 percent from peak value in August 2007 and down 8.6 percent from last year.

The Green Street Advisors Commercial Property Price Index, based on estimates of private market values for REIT portfolios, had been up 3.1 percent in May but remained unchanged in both June and July.

The REIT sector saw positive total returns in July of 1.1 percent, and total one-year returns remained healthy at 23.7 percent. Total returns for the month by property sector range from –4.3 percent for the lodging/resorts sector, the only sector with negative returns, to 4.7 percent for the apartment sector. The NCREIF Property Index turned in a positive second quarter, with total returns of 3.9 percent, continuing the positive returns started in first-quarter 2010. The capital appreciation component was 2.4 percent for the quarter. Total 12-month returns are now 16.7 percent. Total returns for the quarter by property sector range from 2.5 percent for the retail sector to 4.2 percent for apartments and 4.5 percent for both the office and industrial sectors.

CMBS issuance

retreated from $4.31 billion in June, its highest level since March 2008, to $3.73 billion in July, according to Commercial Mortgage Alert. CMBS delinquency rates, according to Trepp LLC, increased to 9.88 percent in July, following two consecutive months of declines, the only monthly declines in nearly two years of steadily rising monthly rates. The current delinquency level is at an all-time high.

For additional commentary on real estate capital markets, see the Capital Markets section of online Urban Land magazine.

Housing

Permits and starts of all types of housing and new single-family home sales remain substantially below their long-term monthly averages, but there were some positive changes: multifamily permits rose to their highest monthly level since October 2008 and starts for all types of housing increased in June. And while sales of new single-family homes fell (modestly), prices increased and are relatively close to their pre-recession peak. In contrast, sales volume of existing homes is above its long-term monthly average but, despite welcome increases in May and June, prices remain significantly below their pre-recession peak. The forward-looking National Association of Realtors (NAR) Index of Pending Sales (of existing single-family homes, condos, and co-ops) stepped up for the second-straight month.

The S&P/Case-Shiller Index for existing home prices increased 1.0 percent in May, the second-straight month of growth after eight months of decline, and is now down 33 percent from the peak in July 2006. (This index, a composite of repeat transactions in 20 cities, is reported monthly as a three-month moving average, with a two-month lag.) The Federal Housing Finance Agency (FHFA) House Price Index (HPI) also rose in May for the second-straight month, by 1.2 percent, after ten straight months of decline; it is down 19 percent from the peak in June 2007. (The HPI covers repeat transactions in the entire country and is reported monthly with a two-month lag.) NAR data (which report individual, unpaired transactions) for May showed a strong 5.3 percent rise in the median price of existing single-family homes, and in June prices increased further, by 8.7 percent; median prices for existing single-family homes stood at $184,600, down 17 percent from the peak in 2006 but the highest monthly median price since November 2008. Median prices for new single-family homes rose 5.8 percent in June to $235,200 after a few months of slight fluctuations and are now down just 5 percent from the peak in 2007.

Single-family building permits were essentially flat, rising only 0.2 percent from 406,000 in May to 407,000 in June. June’s permit numbers remain at 42 percent of the historical monthly average (since 1970) and 23 percent of the pre-recession high in September 2005. Single-family starts, however, increased 9 percent from 414,000 in May to 453,000 and are now at 42 percent of the historical monthly average (since 1970) and 25 percent of the pre-recession high of January 2006.

Sales of new single-family homes

slipped almost 1 percent in June, similar to the decline in May, continuing the zigzagging of the past year, albeit at a less volatile rate. With a drop in inventory, supply decreased from 6.4 to 6.3 months. Monthly sales of new single-family homes in each of the past 14 months have been the lowest since record keeping began in 1963.

The number of existing single-family home sales (seasonally adjusted) remained unchanged at 4.24 million in June from May’s numbers, and is 7 percent above the long-term monthly average (since 1970) and 67 percent of the pre-recession high in September 2005; supply increased from 8.9 to 9.4 months. The forward-looking NAR Index of Pending Sales (of existing single-family homes, condos, and co-ops) increased 2.4 percent in June, following an 8.2 percent increase in May; with two months of increase, most of the 11 percent drop in April has been reversed.

Multifamily building permits increased by 8 percent to 198,000 in June and are now at 51 percent of the monthly average (since 1970). Multifamily housing starts increased by 32 percent in June to 170,000, representing 48 percent of the monthly average (since 1970). Existing condo sales fell by 7 percent to 530,000, just below the long-term monthly average (since 1970); with a decline in inventory, supply fell from 10.9 to 10.2 months.

Housing affordability remains near historical highs.

Foreclosure filings—default notices, scheduled auctions, and bank repossessions—increased by almost 4 percent in June from a month earlier to 222,740, according to RealtyTrac, although filings are 29 percent lower than one year ago. “Processing and procedural delays are pushing foreclosures further and further out,” RealtyTrac notes. “[W]e estimate that as many as 1 million foreclosure actions that should have taken place in 2011 will now happen in 2012, or perhaps even later.”

Home mortgage rates (30-year fixed) barely changed in July and are now 4.55 percent. June’s rate of 4.51 percent was the lowest level in seven months.

Commercial/Multifamily

(Note: The source of some of the data presented in this section of the Barometer has changed: data for office, retail, industrial, and apartment property are now provided by the CoStar Group. Smith Travel Research continues to be the source for hospitality properties.)

Office vacancy rates stood at 13.00 percent in the second quarter, little changed from 13.06 percent in the first quarter of 2011 and 13.15 percent in the same quarter one year ago, according to the CoStar Group. Rents remained stable and are off just 0.8 percent from the same quarter a year ago. The net absorption of 4.5 million square feet of space is almost triple that of the previous quarter; quarterly absorption has been uneven but consistently positive since the second quarter of 2010.

Retail vacancy rates stood at 7.22 percent in the second quarter, little changed from 7.27 percent in the first quarter of 2011 and 7.51 percent in the same quarter one year ago, according to the CoStar Group. Rents remained about the same in the second quarter and are off 3.5 percent from the same quarter a year ago.

Industrial vacancy rates stood at 9.87 percent in the second quarter, down from 10.02 percent in the first quarter of 2011 and 54 basis points below the figure for the same quarter a year ago. Rents stayed the same and are off 2.4 percent from the same quarter a year ago. Net absorption remained strong at 27 million square feet, increasing almost 2 percent over the previous quarter; quarterly absorption has been consistently positive since the second quarter of 2010.

Apartment vacancy rates stood at 6.9 percent in the second quarter, down from 7.2 percent in the second quarter and 80 basis points below the figure for the same quarter a year ago. Rents were up 1.5 percent in the second quarter and are 3.9 percent above rents of the same quarter a year ago. Completions in the second quarter of 2011 stood at 5,775 units, down from the previous quarter and the same quarter a year ago; completions were 21 percent of the quarterly average (since 2001).

Hotel occupancy rates stood at 63.4 percent in the second quarter of 2011, up from 60.7 percent in the same quarter a year ago, according to Smith Travel Research. Completions were down substantially as a percentage of rooms—from 2.1 percent in second-quarter 2010 to 0.7 percent—and are now below the historical average of 2.09 percent. The RevPAR Index was up 8.1 percent from the same quarter of 2010.