12 Trends For 2012 Final Locked[2]
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Transcript of 12 Trends For 2012 Final Locked[2]
January 2012
CBRE Econometric Advisors
SPECIAL REPORT
12 Trends for 2012
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TABLE OF CONTENTS
TREND #1PAGE 3
TREND #2PAGE 4
TREND #3PAGE 6
TREND #4PAGE 8
TREND #5PAGE 10
TREND #6PAGE 12
TREND #7PAGE 13
TREND #8PAGE 15
TREND #9PAGE 18
TREND #10PAGE 19
TREND #11PAGE 21
TREND #12PAGE 23
HOUSING SEARCHES FOR BALANCE
Rising Rents Help to Stabilize Home Prices
SUBURBAN OFFICE WILL CONTINUE TO TAKE PART IN THE RECOVERY
Busting the Myths Suggesting the Death of Suburban Offi ce
CAPITAL FLOWING, BUT ONLY TO THE RIGHT OPPORTUNITIES
Global Picture Shows Eastern European Growth
EMPLOYMENT GROWTH WILL CONTINUE TO MUDDLE THROUGH
Balance Sheets Prevent Level of Growth Needed
SHORTAGES IN LARGE WAREHOUSE SPACE WILL ACCELERATE
Large Warehouses Recovering Faster than Overall Industrial
HOTEL ROOM DEMAND GROWTH WILL SLOW
Overseas Slowdown will Contribute
DEBT MARKET DISTRESS MOVES PAST PEAKS BUT REMAIN HIGH
A Widening Window of Investment Opportunity?
CONSTRUCTION MAY RETURN SOONER THAN YOU THINK
Single Tenant and Delayed Projects Bring Back New Building
RETAIL RENTS FINALLY SEE BOTTOM
Lagging Behind Other Property Types, Last Pieces Fall in Place
MOVEMENT FROM TRUCKS TO TRAINS WILL BE INCREMENTAL
Rise of Rail Inevitable but Slow
IN SPITE OF CAPITAL MARKETS VOLATILITY, FINANCE JOB CUTS TO END BY MID-YEAR 2012
Many Finance Sub-categories Have Seen Losses Level Off
CAP RATE COMPRESSION WILL END
Cap Rates Flat or Worse in the Next Two Years
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TREND #1EMPLOYMENT GROWTH WILL CONTINUE TO MUDDLE THROUGHBalance Sheets Prevent Level of Growth Needed
Productivity Now More Likely to Precede Job Growth
Source: CBRE Econometric Advisors, BLS
EmploymentGDP
ProductivityYoY Growth (%)
10
8
4
2
6
0
-2
-4
-6
1984
Q1
1985
Q1
1986
Q1
1987
Q1
1988
Q1
1989
Q1
1990
Q1
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2012 will mark the third consecutive year that employment
fails to generate much growth. That we begin this period with
a high level of unemployment makes it all the more painful,
and that the upcoming year will again make little progress
in reducing unemployment is frustrating for everyone.
Availability of labor generally encourages businesses to hire,
so unemployment remaining high is surprising; yet what
should be surprising among economists and business leaders
is widely accepted. It is worth examining why there has been
acceptance of high unemployment in this business cycle.
The connection between output and employment is a factor
in this acceptance. That the difference between output
growth and employment growth is productivity, is effectively
a mathematical identity. As such, productivity is part of the
answer to the lack of professional surprise for forecasts
of moderate employment growth in 2012. Output, as
measured by Gross Domestic Product, is our best measure of
demand for work, but increases in output are not suffi cient to
generate jobs because work can sometimes be accomplished
by stretching existing resources, rather than employing new
ones. At no time has this been truer than the recent cycle.
Economists think about productivity both as an important
long-term factor for the economy and also as it relates to
cyclical employment growth. Over longer periods, higher
productivity growth is one of the best things an economy can
produce. It is the foundation of sustainable wage growth
(or at least an expanding pie). Within a cycle, however,
productivity is not always as welcome, as higher productivity
means that businesses can expand without hiring. In recent
cycles, productivity has been highest as output has started to
rebound, with companies fi rst fi nding effi ciencies that would
allow their current workers to accomplish more and only later
resorting to hiring as demand continues to expand. In the
early stages of this expansion, year-over-year productivity
growth was even higher than usual.
In determining where productivity (and therefore employment)
is going in the next year or two, judgments are made. First,
what is the level of productivity growth we should expect in
this expansion, and second, what cyclical effects can we
expect next year? The former question is interesting because
the last three expansions have seen such different levels of
productivity growth. The 1980s and the period from 2004
to 2008 were marked by low productivity growth, while the
1990 tech boom led to growth rates often above 3%.
The slowdown in GDP in 2011—averaging 1.2% in the fi rst
three quarters—affects our views on the cycle of productivity
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TREND #2CAPITAL IS FLOWING, BUT ONLY TO THE RIGHT OPPORTUNITIESGlobal Picture Shows Eastern European Growth
We will look back on 2011, fondly or not, as a year
full of economic and fi nancial shocks that reverberated
throughout the global economy. Volatile global fi nancial
markets, solvency concerns throughout the European
Union, and the combination of sluggish U.S. job growth
and political gridlock in America’s capital led to a drop in
optimism following a number of positive indicators and
reports that characterized the global economic recovery
in early 2011. This uncertainty has dampened both the
already-weak recovery in advanced economies and the
more robust expansion in emerging markets. Meanwhile,
Western Europe is fl irting with yet another recession.
And while the current high level of uncertainty puts any
projection at risk, we expect the pattern of a two-speed
global economic recovery, with pockets of economic
and commercial real estate growth in select regions and
markets, to continue as we head into 2012.
in 2012. Such slowdowns are indeed a setback for the
employment recovery, quite literally. In contrast to similar
stages in the past two cycles, in the past year productivity was
brought down more by slowing output than by improving
employment growth. This puts us back to where we were
some time ago; so, while it won’t be at the magnitude of
2009, we expect to see a period of productivity increase
before we see hiring pick up. As a result, even as we see
GDP improving in 2012 over 2011, it will take much of the
year for this to translate into signifi cant new hiring.
Looking at these factors from another angle, output growth
needs to be exceptionally high to restore the unemployment
situation to normal. To take some round numbers: if we are
around 9% unemployment today, and 5% is more in keeping
with full employment, we need 2% employment growth
above the annual labor force growth of around 1% just to
reduce the unemployment growth within two years. But in
order to obtain the 3% employment growth target we just
arrived upon, we need GDP growth to be 2 percentage points
faster, to overcome the expected increases in productivity.
In short, growth rates need to be routinely 4% to 5% over
many quarters to see the type of job recovery that has been
more typical in the post-war era.
So while there is some relief when GDP growth makes it
above 2%, this is more about the economy having what it
takes to avoid dipping back into recession, than it is about
the economy improving in any way that the average citizen
will appreciate. Indeed, recent job gains, retail sales, and
industrial production have increased enough to make us
comfortable that a recession is not imminent. Unfortunately,
we also believe that output growth will stay in the 2% range
for much of 2012.
The reasoning has to do with to the differences between
more typical recessions and what some have called the
“balance sheet recession” we are seeing today. The distinct
feature of the recent recession is the high level of debt and
the need across much of the economy to deleverage from
those high levels. If we are to achieve 5% GDP growth, a
good anchor would be for consumers to spend at a similar
pace. This has happened in the past as consumers have
made up for delayed purchases, but the necessity to pay
down debts has placed a limit on how fast consumers are
willing to increase spending. We could turn to investment,
but the overhang of housing means that the major category
of residential investment will be moribund for a few more
years. Net exports were previously a hope for an increase
in GDP, but the European crisis closed off this avenue in
2011. Government is the last remaining category and one
need look no farther than the September debt ceiling crisis to
become dispirited about any assistance being offered there.
What has not been discussed enough is how the rise of the
fi libuster suggests that the future will insure no assistance as
well, regardless of the results of this November’s elections.
Until these conditions change—say, after debt is better paid
down or housing has begun its recovery—it is hard to see
enough aggregate demand coming through to change the
employment situation in the way we all would like. This
explains why there are very few optimists expecting anything
more than “muddling through” over the next few years.
On the brighter side, trends have been seeing gradual
improvement in all the underlying constraints mentioned
in the above paragraph, so expectations for a return to
recession remain rare among economists. From this
standpoint there is contentment with “muddling through”,
as it is better than the next most likely alternative.
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Source: IHS Global Insight as of Q3 2011.
The Multi-Speed Economic Recovery Continues
Real GDP, YoY % Change
8
10
2
4
6
0
-2
-6
-4
-8
2005
Q1
2007
Q1
2006
Q1
2009
Q1
2010
Q1
2014
Q1
2008
Q1
2013
Q1
2011
Q1
2012
Q1
Western EuropeUnited States
Asia Pacifi cWorld
The Investment MarketDespite a backdrop of deteriorating European economic
and fi nancial market indicators, property investment held
up well in 2011. Globally, commercial property transactions
(excluding land sales) in the fi rst three quarters of 2010
increased by 40.3% compared to the same time period
during the previous year. Regionally, growth was strongest
in the Americas (+71.6%) followed by EMEA (+31.2%) and
Asia Pacifi c (+16.8%).
Recent surveys point to continued investment in commercial
property—transactions remain below their pre-recession
peaks, but volumes continued to recover in 2011.
Transaction volume is expected to remain steady in 2012,
even in Europe; according to the European Central Bank,
approximately a third of outstanding commercial property
mortgages are expected to mature by 2013. Prevailing
Global Transaction Volume Continues to Recover
Source: Real Capital Analytics
2007
Q1
2008
Q120
08Q2
2008
Q3
2010
Q3
2007
Q2
2009
Q120
09Q3
2011
Q220
11Q1
2008
Q420
09Q1
2010
Q4
2007
Q320
07Q4
2009
Q420
10Q1
2010
Q2
2011
Q3
Quarterly Transaction Volume by Region, billions
$140
$120
$80
$100
$60
$40
$20
0
Asia Pacifi cEMEA
Americas
commercial property prices remain below their pre-
downturn peaks, exposing investors to high refi nancing
risks, which may increase property sales as investors seek
to raise capital.
Can We Find Growth Anywhere?Europe presents a prime case of how demand drivers for
real estate exist even in the face of economic uncertainty.
The early days of the economic recovery were marked by
strong investor interest in prime assets in prime markets,
with trophy offi ce buildings in major markets such as London
and Paris experiencing great interest and bidding activity.
Germany and France—traditionally real estate investment
magnets, both of which have so far outperformed the
overall Eurozone in terms of economic growth—attracted
a great deal of capital targeting their commercial property
sectors. But with the economic recovery waning as a result
of sovereign debt concerns, investors are searching for
properties beyond traditional hotspots. This is evidenced
by recent acceleration in cross-border activity targeting
the commercial property sector. According to Real Capital
Analytics, in the third quarter of 2011, the percentage of
trading volume involving cross-border capital reached its
highest point in three years. And while the usual markets
in U.S., France, Germany and the UK continue to attract
capital, yields in these markets have fallen and cross-border
investors are shifting to other areas of Europe despite
concerns over the future of the European Union. Investors
have begun to look at other areas, such as Poland, Russia
and Turkey. Recent surveys show a marked increase in cross-
border transactions in Central Eastern European markets,
where governments are not straddled with the overarching
debt issues of many of their larger neighbors.
The increased investor interest in Central and Eastern
Europe refl ects growth in the demand for certain classes of
commercial property. Of the fi fteen global offi ce markets
with the strongest growth in occupied offi ce stock over
the past year, nine are located in the region. Warsaw, for
example, was the only EU nation to avoid a recession in
2009, and experienced a 6.5% increase in occupied offi ce
space during the past four quarters. Other markets in the
region recording similarly strong performance include
Moscow, Kyiv, St. Petersburg, and Prague.
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Offi ce Hotspots in 2011
MarketGrowth in Occupied
Offi ce Stock (Q3 2010 - Q3 2011)
Abu Dhabi 25.8%
Guangzhou 19.2%
Shanghai 15.2%
Beijing 14.5%
Kyiv 12.6%
Moscow 11.7%
Bucharest 11.1%
Mexico City 10.5%
St. Petersburg 9.9%
Sofi a 9.5%
Belgrade 8.8%
Warsaw 6.5%
San Jose 4.5%
Bratislava 5.4%
Prague 4.6%
Source: CBRE Research
These markets are enjoying demand for offi ce space from
international as well as domestic occupiers. Healthier
government balance sheets, relatively low labor costs,
and high rates of education have attracted a number of
international companies, both from continental Europe
and beyond.
SummaryThe outlook for the coming year is very dependent on
governmental policy responses—which makes the level of
uncertainty high. Policy responses have been inadequate
and slow across the globe, and this shows no signs of
changing. Commercial property data, however, point to a
number of markets that have experienced positive growth in
occupier and investment demand—even in Europe—despite
the uncertainty. That economic momentum remains uneven
will continue to drive investment activity both within and
across borders.
TREND #3HOUSING SEARCHES FOR BALANCERising Rents Help to Stabilize Home Prices
Can housing fi nally fi nd a bottom in 2012? There are
some good reasons to think that it can, as long as one
looks at the whole market, rather than just the for-sale
segment. Total household growth and new construction
should strengthen as the economy adds more jobs and
the unemployment rate drops. It is important to see the
two sides of this trend, however—their interaction is what
ultimately drives the housing recovery.
Owner-occupied units account for about two thirds of
the nation’s housing demand. Given the still-high rate of
foreclosures and their negative impact on home prices and
sales, it is likely that owner demand will continue to struggle,
although perhaps not as much as it did last year. At the
same time, rental demand is expanding at a near-record
pace that is well ahead of supply. As a result, vacancy is
falling and rents are rising in every region of the country—a
key building block for an eventual recovery in home prices.
The housing market is being shaped by many countervailing
forces. The costs of buying a home now are record-low
relative to both household incomes and rents, which
makes pursuing homeownership today an opportunity of
a generation. At some point, this high and rising housing
affordability should unleash pent-up demand, leading to
rising sales and prices. The chart below illustrates this,
displaying the ratio of monthly principal and interest
payments on a median-priced home, to rent. This ratio is
computed historically using the all-transaction home price
and apartment rent index. In 2011, for example, with a
4.9% interest rate, the cost of owning a $250,000 home
purchased with a 20% down payment comes to about
$1,100 a month—which is very close to the current national
average rent. It turns out that the current ratio is not only
more than 20% below the historical average; it is also at
a record low over this period.
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Housing Affordability is at a Record High
Ration of monthly principal and interest to rent, 2011Q3=1
1.7
1.6
1.4
1.3
1.5
1.2
1.1
1.0
0.9
1986
1994
1996
2010
1988
2002
2004
1998
2000
1990
1992
2006
2008
2006-2011 average
Sources: Federal Reserve, FHFA, MPF Research, CBRE Econometric Advisors.
Whether it does unleash demand ultimately depends on
households' view of homeownership in this fragile market.
This view is being shaped by three factors. First, with
hundreds of thousands of homes entering foreclosure
every month, some buyers expect further declines in home
prices, or are uncertain about the fair market value of
homes. Second, the labor market is still too weak to boost
confi dence much and with the unemployment rate high, it
takes a person longer to fi nd a job today than it did in the
past. In such an environment, households have to be able
to move quickly to where jobs are. Being that it takes time
to sell and buy a house, mobility and homeownership are at
odds with one another. A third factor is buyers' expectations
for building equity while owning homes. With property taxes
and maintenance costs high and home price appreciation
yet to resume, home ownership does not yet look like the
sure investment it used to be. Another key impediment to
home ownership is that higher mortgage down payment
requirements, combined with depleted household savings,
are making it much harder for households to qualify for
loans. As long as unemployment remains high, rebuilding
credit will be a slow process for most households, and
will be particularly challenging for those who are near
retirement.
Foreclosures remain a major drag on housing appreciation,
and progress in stemming them has been slow. While rates
of foreclosure starts and completions have declined from
the peak, the share of mortgages in foreclosure remains
near its record high of 4.5%. Distress is likely to continue
to affect home sales and prices during 2012’s spring
and summer home-buying season, considering that the
labor market is not expected to gain much traction until
the second half of the year. At the same time, this impact
should be less negative than in 2011, if the economy does
show steady improvement in the fi rst half and the so-called
“strategic defaults” do not intensify. Under this more
optimistic scenario, almost 0.5 million households will still
lose homes, which would push the homeownership rate
down by another 30-50 basis points. As a result, prices
will still decline, but probably by only 1-2%, as compared
to the 3-4% in 2011, when the losses to owner demand
were also more severe.
The U.S. Homeownership Rate is Likely to Continue Declining in 2012
Sources: Bureau of the Census (Housing Vacancy Survey), CBRE Econometric Advisors
Homeownership RateRenter Households
Homeownership Rate, % Renter Households, Millions
7170
68
66
64
62
4240
3638
32
28
24
34
26
2220
67
69
65
63
6160
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
30
The silver lining to this is the accompanying expansion in the
number of renter households: combined with demographic
growth, the shift from owning to renting should yield over
0.7 million new renters. As a result, growth in rental
demand will exceed supply next year, although not by
as much as one might expect. While new completions
intended for rent will be low by historical standards—near
0.2 million units—rental stock will also add over 0.4
million units through conversions from owner-occupied
and vacant for-sale units. More than 4 million units
have been converted to rentals since 2004, signifi cantly
constraining improvement in the rental vacancy rate—and
conversions will remain a signifi cant headwind, especially if
owner demand falls. Considering this, rent growth should
approach its long-term average of about 3%, but a much
stronger infl ation will prove challenging.
Home prices remain under pressure from a major
imbalance brought about by the housing boom and bust
of the last decade: there are about 2.5 million more
vacant units than there were prior to the correction. Of this
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on their way to gradually becoming a thing of the past, as
individuals are choosing more central, urban locations with
easy access to mass transit, restaurants, cultural activities
and their places of work. Such a trend would not only have
a major impact on residential real estate, but it would also
present a signifi cant challenge to the sustainability of the
nation’s suburban offi ce markets.
The problem with the argument for the de-suburbanization
(or re-urbanization) of America to this point is that it is less
theory than it is a hypothesis that has yet to be fully tested.
The story of a population base shifting from suburban to
city locations sounds plausible, but the lack of empirical
evidence thus far makes it hard to defend. While data
from the most recent decennial Census show that cities are
indeed growing, they also show that they are not growing
any faster in most cases than their suburban counterparts.
None of this matters, however. If a story gains enough
traction, it can take on a life of its own—even without the
research or data to back up the argument. For their part,
commercial real estate investors appear to have bought into
the argument for the renaissance of center cities, and are
adopting strategies to divest themselves of suburban assets.
Transaction data have shown that over the past year an
increasing share of deals has been based in downtowns,
as investors view these assets to be more liquid, and are
willing to buy yields below 5% in markets like New York.
But investor behavior does not fully support the argument
that the suburban offi ce market is dead as much as it
reveals something about investor appetite for risk at this
stage in the recovery. Investment activity has been focused
largely on core assets in high-profi le locations in markets
like New York, Boston and San Francisco; the reasoning
is that prime downtown locations offer a buffer against
downside risk by way of increased liquidity, when compared
with suburban locations. This is nothing new, however, as
investment typically picks up for well-located core assets
fi rst during a recovery, then spreads beyond downtowns and
into suburban locations as investors grow more willing to
take on more risk to expand their portfolios.
Another way to look at this argument is through property
fundamentals. If a secular shift is occurring away from
suburbs and toward downtowns, surely this should manifest
itself in the property data. We can start by looking at
demand for offi ce space, which should reveal location
inventory, only 0.5 million units are on the market, however,
and this has a direct impact on prices. Current household
growth is 0.7 million per year (half the historical average)
and with home demolitions of 0.3 million, new demand
must be close to a million units and well ahead of the 0.6
million in new completions. Household growth is a largely
a function of labor market conditions, and with a stronger
pace of recovery, virtually all of the excess supply for rent
and for sale could be absorbed by the end of next year. The
negative effect that the glut of vacant homes on the market
is having on prices would subside as a result.
It is much harder to foresee how many of the homes now in
the “shadow” inventory might be put up for sale next year.
Historically, the share of these units entering the market has
increased when buyer demand and prices were strong—
which will not be the case in the near term. At the same
time, many of these units are non-primary residences, so
it is possible that more owners will decide to strategically
default on their mortgages this time around—especially in
areas were home prices are still down by more than 20%.
Investors’ views of the market will play a major role in
shaping their decisions.
In summary, U.S. housing should see a slight improvement
in price trends along with moderate rent growth in 2012,
preparing ground for a more sustained recovery later.
Rising rents can help to stabilize home prices but any
real progress can only take place when households have
trust and confi dence in the economy—including a more
robust job market and an expectation of building home
equity—and enough resources to qualify for mortgages.
Foreclosures remain the major wild card and as such the
outlook will depend on how quickly they are being resolved.
In this regard, 2012 can be viewed as a transition year for
the U.S. housing market.
TREND #4SUBURBAN OFFICE WILL CONTINUE TO TAKE PART IN THE RECOVERYBusting the Myths that Suggest the Death of Suburban Offi ce
There has been no shortage of discussion lately about the
death of the suburbs as an American institution. Some
metropolitan population pundits suggest that suburbs are
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preferences for businesses. Historically, net absorption in
absolute terms has favored suburban markets, but in recent
decades this has largely been a function of the relative
size of the suburban offi ce market, which today makes up
roughly two-thirds of the nation’s offi ce market. Looking at
the net absorption rate, which accounts for the relative size
of the market, allows for a more fair comparison.
When these series are graphed, we can see the relative
demand trends for downtown and suburban offi ce space.
What we see is that the recession’s demand fallout was
far more severe for downtowns, and that they still have a
great deal of ground to make up. Moreover, there is not
a discernible difference between downtown and suburban
offi ce demand in the period since the recovery began,
despite the perception that most of the improvement has
been in core locations.
One might even argue that suburban offi ce has outperformed
downtown, in terms of demand. With respect to core
performance in downtowns, just a handful of markets are
showing solid performance. New York is perhaps the best
and largest example of this type of improvement, but it
also skews the results. By itself, New York has accounted
for nearly half of all downtown demand year-to-date, and
a comparison of downtown versus suburban offi ce without
New York produces a very different result, and a different
view of relative performance.
Source: CBRE Econometric Advisors.
Are Suburbs Lagging or Leading in the Recovery?DowntownSuburban
Downtown ex-New YorkOccupied Stock, YoY % Chg.
4
3
1
2
0
-1
-2
-3
2007
.1
2008
.120
08.2
2010
.1
2007
.2
2009
.120
09.2
2010
.3
2008
.320
08.4
2010
.2
2007
.320
07.4
2009
.320
09.4
2010
.420
11.1
2011
.220
11.3
2011
.420
12.1
2012
.220
12.3
2012
.4
Leasing decisions in markets like New York are usually
refl ective of corporate conditions and planning rather than
outright business formation and job growth. Without this,
the picture of strong downtowns emerging and leading
the offi ce market recovery simply does not hold up across
the board. In fact, we see a picture that suggests that the
strength of the offi ce market recovery is more focused on
submarkets outside of the nation’s CBDs. In itself this is
not all that surprising; historically, demand for suburban
offi ce space has outpaced that of downtown locations. What
might be surprising at this point, then, is that demand in
downtown offi ce markets has managed to keep pace with
the broader trend.
But this also highlights an important distinction between
submarkets and markets. When we talk about downtown
versus suburban markets, we are comparing many
different and diverse submarkets within cities and broader
metropolitan areas, respectively. It is entirely possible for
pockets of strength to lead to more robust results for a
particular market. In New York’s downtown submarkets, for
example, this can be seen by looking at Sixth/Park Avenue
and perhaps World Financial Center (WFC), where vacancy
rates are well below market average and are outperforming
their suburban counterparts. While these may be attractive
submarkets, investors will also have to pay a price for such
prime locations, in the way of lower yields.
Another argument for downtown offi ce investment has to do
with rent and vacancy. True, vacancy rates in the suburbs
tend to run higher than downtown markets, and tighter
leasing markets support rent growth, which drives income
and returns. But vacancy rates don’t in themselves dictate
rent growth—it’s the market or submarket equilibrium
vacancy rate level that is important. To that point, both
downtown and suburban vacancy remains elevated and
above what would support rent growth on par with broader
infl ationary measures. But this is changing and the rent
cycle has shifted from correction to recovery.
Downtown offi ce rents have historically grown faster during
upswings, which can attract investors when the market is
on the way up—but they fall faster during corrections.
Because downtown rent cycles see such wide oscillations,
average growth between downtown and suburban offi ce
markets is statistically diffi cult to distinguish over the past
20 years—something that will not change anytime soon.
While rent growth in downtowns has picked up faster than
in the suburbs, much of this can be attributed to a very
small core of markets—and submarkets. Once landlords
regain a measure of pricing power in downtown markets
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they tend to move more aggressively in order to maximize
operating income during the upswing. Again, excluding
New York gives us a much different perspective that shows
that rent growth across most markets is roughly the same.
Also, those investors who bought at the height of the market
in downtown locations, thinking they were hedging their
bets, are now facing the threat of diminished cash fl ows
as those leases are starting to roll. This is something worth
considering even in a market like New York, or perhaps San
Francisco, where rents dropped in excess of 20%, peak to
trough, before beginning to rebound. Building owners in
these markets will need every bit of that accelerated growth
to cover leases signed at the top of the market.
The offi ce market continues to face a lengthy recovery
and after a transition in 2011, next year will be another
important step on the road back. The talk about the
downtown renaissance and suburban demise will likely
continue, but you won’t hear it from us—at least not as part
of an argument on permanent trends. Sure, downtown core
assets will continue to trade at a premium and rent growth
will likely outpace its suburban counterpart; that won’t be
by much, however, and performance will be mixed, with the
best downtown submarkets leading improvements. There is
also little evidence that demand for offi ce space in suburban
business parks is likely to evaporate any time soon.
The point in all of this is not that 2012 will be the year of
the suburbs or that investors should alter their investment
strategies and divest themselves of downtown assets.
Investors like downtowns for a number of valid reasons,
including longer lease length, access to capital for liquidity
and potential for NOI growth in an up market. Rather, our
aim is to shed light on a debate that has gained a great
deal of traction in the press without having a good deal
of supporting data. For their part, investors should be
conscious of whether their decisions are based on headlines
and perceptions of new urban theory, and they should look
to how much empirical evidence exists to support their
perceptions.
TREND #5SHORTAGES IN LARGE WAREHOUSE SPACE WILL ACCELERATELarge Warehouses Recovering Faster Than Overall Industrial
It comes as no shock to property investors to hear that the
recent recession ravaged the industrial sector. The sour
economy, falling trade and inventories, and plunging
industrial production conspired to push the availability
rate in the nation’s industrial sector to a record high. With
the recession now over and many of the sectors’ primary
demand drivers recovering nicely, industrial property has
reported healthy demand every quarter for the past year.
Looking deeper, however, it becomes clear that 2011 will
go down as a year of consolidating and upgrading by
occupiers.
Lots of available space combined with very low rent
levels has provided great opportunities for occupiers to
consolidate space or upgrade to higher-quality space.
Consolidation is being reported in markets all over the
country, with fi rms consolidating multiple smaller facilities
into fewer larger ones in a constant drive to reduce
Source: CBRE Econometric Advisors.
Demand for Large Buildings Held Up Comparatively Well During the Recession
Source: CBRE Econometric Advisors.
Little Difference in Rent GrowthDowntownSuburban
Downtown Ex-New YorkTW Rent Index, YoY % Chg.
20
15
5
10
0
-10
-5
-15
-20
2000
.1
2002
.120
02.3
2006
.1
2000
.3
2004
.120
04.3
2007
.1
2003
.120
03.3
2006
.3
2001
.120
01.3
2005
.120
05.3
2007
.320
08.1
2008
.320
09.1
2009
.320
10.1
2010
.320
11.1
2011
.320
12.1
2012
.3
SmallBigAbsorption Rate
1.2
1.0
0.6
0.2
-0.2
0.4
0.8
0
-0.4
-0.6
-0.8
2000
.1
2002
.120
02.3
2006
.1
2000
.3
2004
.120
04.3
2007
.1
2003
.120
03.3
2006
.3
2001
.120
01.3
2005
.120
05.3
2007
.320
08.1
2008
.320
09.1
2009
.320
10.1
2010
.320
11.1
2011
.3
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expenses. This has led to above-average demand for larger
facilities during the past year. For almost the entire recession
and specifi cally for the last four quarters, the nation’s largest
industrial facilities—those of more than 500,000 sf—have
been experiencing positive demand.
The recession offi cially started during the fourth quarter of
2007, and large buildings have reported comparatively
robust demand since the beginning, with average quarterly
demand of nearly 4 msf, compared to -5.9 msf for smaller
facilities. For the past year, large buildings have been
responsible for 18% of all the absorption in the nation’s
industrial sector, yet large buildings account for only
13% of the nation’s stock of industrial space. This strong
absorption has allowed the large building segment to
see its availability rate fall 100 bps since the peak of the
recession, to 12.5%; the country’s smaller buildings have
seen a decrease of 90 bps over the same period, to 14%.
While those two fi gures are not dramatically different, the
availability decrease among large buildings is impressive
when you consider that large buildings also accounted for
44% of all construction during the period—a far greater
share than we’ve seen at any point in our history. But though
the share of total construction is high, absolute levels of new
construction remain very low, currently running at about half
of what is being demanded. Over the past four quarters,
the construction rate for large buildings has been 0.16%,
while the absorption rate has been 0.39%.
Record-high construction of large buildings during the early
stages of the recession, combined with weakening demand
as the economy soured, led to a rapid rise in the availability
rate of large buildings. The large building availability rate,
which historically has been several percentage points below
the overall sector, rose faster and sooner than that of all
buildings early in the recession, until it was essentially in
line with the overall industrial sector. The recession caused
new construction to pull back dramatically for all types of
buildings, even as demand for large buildings remained
positive during most quarters. This allowed the segment’s
availability rate to stabilize sooner, and to drop faster, than
that of the overall industrial sector.
Although nationally the demand for large buildings has
certainly outpaced demand for small buildings, availability
rates are comparable, due to relatively high large building
construction. In some markets the difference is far greater,
however, and shortages are being reported in places.
Austin, for example—a smaller industrial market where
larger buildings comprise just under 10% of industrial
space—has no available space in its largest buildings.
Houston and Riverside, two of the largest markets we cover,
with great infrastructure and transportation networks, are
both reporting availability rates below 5% among their
largest buildings, versus double-digit rates for the market
as a whole.
Source: CBRE Econometric Advisors.
Shortages Now Bring Reported in Some Markets
Current Availability Rates (%)
Market Large Buildings Market Level
Austin 0.0 14.4
Houston 4.5 10.2
Riverside 4.8 12.1
Minneapolis 7.0 11.4
Denver 8.2 12.7
Chicago 12.5 15.4
Atlanta 15.1 18.1
Nation 12.5 13.7
As the economy continues to recover and the industrial
recovery spreads, 2012 will see more of these spot shortages
show up, as rents still are too low to justify substantial new
construction. In Atlanta, where the recovery has been slower
than the nation’s, and where there currently isn’t a shortage
of any type or size of space, the large building segment is
now showing signs of strength. The large building segment
in Atlanta has seen availability rates fall 330 bps from their
recessionary peaks, compared to a decline of 140 bps for
Source: CBRE Econometric Advisors.
Availability Rates Stabilized Sooner for Large Buildings
SmallBigAvailability Rate, %
16
12
8
14
10
6
4
2
2000
.1
2002
.120
02.3
2006
.1
2000
.3
2004
.120
04.3
2007
.1
2003
.120
03.3
2006
.3
2001
.120
01.3
2005
.120
05.3
2007
.320
08.1
2008
.320
09.1
2009
.320
10.1
2010
.320
11.1
2011
.3
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2TREND #6HOTEL ROOM DEMAND GROWTH WILL SLOWOverseas Slowdown will Contribute
This hotel recovery has been one for the record books.
After a near-halting of business and leisure travel during
the recession brought a signifi cant decline in demand for
rooms in 2008 and 2009, the hotel industry has witnessed
dramatic demand improvement since the economy has
begun to show signs of recovery. A rapid increase in
international tourism helped to fuel the demand recovery in
the U.S., but as global unbalance has plagued travelers in
recent months, international tourism has dropped. Another
the market overall. Similar trends are starting to show in
Dallas, where a massive large-building boom that lasted
through the early parts of the recession pushed availability
rates of large buildings above 22%, while the market as a
whole registered 17.1%. Since the recession has ended,
however, the availability rate has fallen much faster for the
large building segment, with its current availability rate now
comparable to the market’s overall 15.3% rate.
Looking to 2012, as the economy continues to steadily
recover and hopefully even to accelerate, it is clear that we
will start to see increased spot shortages—particularly of
the largest industrial assets. The economy-of-scale benefi ts
expected from building super-large assets have historically
been constrained by the technological diffi culties of heating
and cooling those assets, such that taking advantage of
their immense size in a cost effective way has been diffi cult.
However, recent technological improvements have allowed
for more of these buildings to be built and for occupiers to
benefi t from their scale. Larger buildings that are now cost
effective to run and manage will lead to more consolidation
among fi rms that currently use several smaller facilities.
And with supply chains increasingly dependent on cheap
and reliable transportation systems, recent rail investments
also have the potential to encourage fi rms to consolidate
multiple facilities into a single one located near a strong
intermodal network, reducing the high costs associated
with truck shipments. With minimal new construction
and fewer buildings available to be leased up, in 2012
this consolidating trend will have only shortages of large
buildings to constrain it.
The rapid recovery in demand for hotel rooms, which
began as early as mid-2009, was historic. Reaching
growth rates of 10% on a year-over-year basis, the rate
of rebound well surpassed the recovery that followed the
2001 recession, despite the fact that the demand declines
during this recession were slightly less severe than in 2001.
Since that historic 10% growth, the demand growth rate has
decelerated consistently and currently reads around 5%.
The pattern is similar to what we witnessed following the
demand spike in 2004, when the pace of demand growth
fell consistently until 2006, even declining for a couple of
quarters before stabilizing at around 0.5% in 2007. The
more recent sharp improvement in hotel room demand
helped us achieve expansion by the end of 2010. Demand
growth will likely stabilize in the coming quarters.
During the recent hotel recovery, the boost in demand has
come from international, rather than domestic, travelers.
Just as demand growth was reaching 10%, international
tourism growth was achieving nearly the same growth
figures, while domestic travel remained much lower.
International travelers were most likely taking advantage
of the low room rates, but rates have risen since then
and the global crisis is creating international tourism
Source: CBRE Econometric Advisors.
Robust Demand Recovery UnderwayDemand Growth (R)
4 Qtr. Moving Avg. Demand
SF x 1000 Demand Growth, YoY (%)
1500
1400
15
10
5
0
-5
-10
-15
1200
1300
1100
1000
900
800
1988
.1
1992
.119
93.1
2000
.1
1989
.1
1996
.119
97.1
2002
.1
1994
.119
95.1
2001
.1
1990
.119
91.1
1998
.119
99.1
2003
.120
04.1
2005
.120
06.1
2007
.120
08.1
2009
.120
10.1
2011
.120
12.1
2013
.120
14.1
factor in boosting the demand recovery in its early phase
was that room rates fell to historically low rates during
the downturn; ADRs remaining low well beyond the start
of the demand recovery has only compounded the effect.
Though the hotel recovery has remained resilient, growth
has diminished a bit and factors will arise in the coming
quarters to diminish growth even further.
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The severity of the recent downturn caused room rates to
record historic, severe declines. When room rates stopped
declining at the end of 2009—at levels recorded in mid-
2006—the downturn had taken almost three years worth of
pricing power away from hotel owners. Unlike in the 2001
recession, when demand declines were less pronounced,
hotel owners slashed room rates in order to keep demand
from sliding even further into the red. This has translated
into rates that are still 8% below their previous peak, even
following several quarters of growth. Hoteliers were quick
to start increasing rates again soon after there was proof
that the hotel demand recovery had legs. Over the coming
quarters, hoteliers are going to continue to trade away
accelerating demand growth for ADR growth, which is
another reason we will see demand growth for hotel rooms
continue to diminish.
Several factors, then, will cause demand growth to continue
to diminish in 2012. The historic demand growth rate
of 10% at the onset of the hotel recovery was, of course,
unsustainable, and with growth having diminished for the
past several quarters, there is momentum toward further
slowing in 2012. A European economic crisis could put a
signifi cant damper on already-weakened international travel
to the U.S., which has been a driving force through much of
this hotel demand recovery, and accelerating growth in room
rates will only compound the issue. But demand fl attening
out in 2012 does not mean the end to the demand recovery;
demand for rooms will continue to expand, just not at the
boosted rates recorded coming out of the recession.
DomesticInternational
Hotel DemandPassenger Enplanements: Yr/Yr Growth (%)
30
10
20
0
-10
-20
-30
1997
1999
1999
2003
1997
2001
2001
2004
2000
2000
2003
1998
1998
2002
2002
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
2009
2010
2010
2011
Source: CBRE Econometric Advisors, BTA.
Domestic or International Travel Causing Boost in Demand?
Source: CBRE Econometric Advisors.
Occupancy Growth Gives Way to ADR Growth
APR Growth (R)4 Qtr. Moving Avg. ADR APR Growth, YoY (%)
$140
$130
$120
15
10
5
0
-5
-10
-15
$100
$110
$90
$80
$70
$60
1988
.1
1992
.119
93.1
2000
.1
1989
.1
1996
.119
97.1
2002
.1
1994
.119
95.1
2001
.1
1990
.119
91.1
1998
.119
99.1
2003
.120
04.1
2005
.120
06.1
2007
.120
08.1
2009
.120
10.1
2011
.120
12.1
2013
.120
14.1
TREND #7DEBT MARKET DISTRESS MOVES PAST PEAKS, BUT REMAINS HIGHA Widening Window of Investment Opportunity?
As 2012 unfolds, equity investors may continue to be wary
of the competition and high prices paid for core assets, and
some may rethink their strategy and risk/return parameters.
However, debt investors that have capital to deploy may be
well positioned to take advantage of growing opportunities
to fi nance fi rst mortgages and strategically re- capitalize
maturing loans that are backed by quality properties. While
uncertainty regarding future upward movement in interest
rates is a concern for debt and equity investors alike, those
in the debt world may see an opportunity to earn favorable
risk-adjusted returns—especially under a scenario where
growth in property values stalls from downward pressure
on net operating income. Permanent fi rst mortgage and
mezzanine lenders will continue to benefi t from a growing
pipeline of loan maturities that will be in need of “gap”
fi nancing.
uncertainties, which will most likely have a negative effect
on hotel demand growth in coming quarters, particularly
as the UK, Germany and France are three of the top ten
tourist generating countries for the U.S., in terms of the
number of arrivals, according to the Offi ce of Travel and
Tourism Industries. Domestic travel did witness a slight
surge in 2010, but since that time it has diminished. The
demand growth witnessed so far in the hotel recovery is
not sustainable, given these trends in travel.
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What are some of the important trends that have emerged
in recent months that will set the stage for the real estate
debt capital markets in 2012?
Debt availability continues to improve, but the progress
remains decidedly uneven. The CBRE Debt Momentum
index indicates that lending volume almost doubled for
the year ended in the third quarter of 2011. Despite
the gains, lending volume remains at less than one-
half of 2007’s peak level. The life companies and
lending agencies (Fannie Mae, Freddie Mac) have
contributed disproportionately to this year’s gains
and are likely to remain reliable sources of fi nancing
in 2012. Bank lending also revived substantially over
the course of 2011; lending conditions are likely to
remain constrained in secondary and tertiary markets,
however, as local and regional banks continue to
work through their distressed commercial real estate
portfolios.
The CMBS pipeline thinned this fall due to spread-
widening and uncertainty in the capital markets. The
withdrawal of a few key lenders from the CMBS sector
has also raised additional concerns about future
market growth. As a result, some observers fear that
2012 CMBS origination volume will struggle to surpass
the approximately $31 billion originated in 2011.
CMBS lending will be critical to improving liquidity in
2012, especially in secondary markets and among
B-quality properties.
Less competition has caused loan spreads to become
more favorable to lenders: while quoted spreads on
commercial fi xed-rate permanent loans appear to
have tightened slightly from this year’s highs recorded
in August, they are still anywhere from some 40-75
bps wider than May’s lows, depending on property
type and loan-to-value ratio, according to Trepp. This
largely follows the pattern in CMBS spreads which
evolved over the course of the year. At the same time,
with the downward shift in the yield curve, borrowers
now benefi t from lower all-in borrowing costs.
Underwriting parameters appear to have stabilized:
after a fl urry of CMBS origination in the fi rst half
of 2011, CMBS investors began to object to lower
subordination levels amid looser underwriting
standards and the reappearance of interest-only loans.
However, overall underwriting parameters appear
to have stabilized in recent months. CBRE Capital
Markets tracks the average loan-to-value (LTV) on
new-issue, permanent, fi xed-rate loans. (Exhibit 1)
After a period of tight underwriting standards that
lowered average commercial LTVs signifi cantly during
the recession, LTVs recovered markedly during 2010
and then stabilized over the course of 2011. Given
the sluggish recovery in real estate fundamentals,
lenders are likely to remain generally risk averse; as
a result, it appears that underwriting standards will be
maintained in the near future.
Distressed loan resolutions and loan sales have risen
over the course of 2011, which could continue to exert
downward pressure on distressed property prices, which
have been fl at to declining over most of 2011. (Exhibit
Source: CBRE Econometric Advisors.
Exhibit 1: Loan-to-Value Rations Stabilize
Non-HousingHousing-RelatedAverage LTV %
80
70
75
65
60
55
50
2003
.1
2005
.120
05.3
2009
.1
2003
.3
2007
.120
07.3
2010
.1
2006
.120
06.3
2009
.3
2004
.120
04.3
2008
.120
08.3
2010
.320
11.1
2011
.3
Average LTV for deals with fi xed rate permanent debt
Source: CBRE Econometric Advisors.
Exhibit 2: More Downward Pressure on Distressed Property Prices to Come?
CPPI Distressed Property Price IndexNet Qtrly Distressed Property Resolutions ($ Bil.) (R)
Repeat Sales Price Index
250
150
200
100
50
0
Oct-0
7
Jun-
08Au
g-08
Oct-0
9
Dec-0
7
Feb-
09Ap
r-09
Oct-0
8De
c-08
Dec-0
9
Feb-
08Ap
r-08
Jun-
09Au
g-09
Oct-1
0
Apr-1
0
Dec-1
0
Apr-1
1Fe
b-11
Jun-
11Au
g-11
Jun-
10Au
g-10
Property Resolutions, $ Bil.
25
15
20
10
5
0
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TREND #8CONSTRUCTION MAY RETURN SOONER THAN YOU THINKSingle Tenant and Delayed Projects Bring Back New Building
The recent downturn in the commercial property markets
was largely a demand-driven phenomenon, with businesses
failing and returning empty space to the market. By
contrast, the commercial real estate downturn of the late
1980s and early 1990s was heavily supply-driven, with an
excessive quantity of new construction sitting as an anchor
around the neck of property market performance for much
of the early 1990s. Many investors are banking on the fact
that there is no such anchor holding back the commercial
property markets today, and anticipating performance to
rebound sharply once demand returns.
We think that these investors are right to assume that the
shutdown of new supply will have an impact on property
market performance. All other things equal, any short-
term interruption of supply will push up rents for existing
properties as tenants scramble to fi nd suitable space.
This said, we do believe that some investors are being
overoptimistic in this regard. Some assume that our
2) With some $80 billion specially serviced loans in
need of resolution, and the prospect of additional
defaults among bank development deals, it’s likely
that we’ll see growing demand for opportunistic
capital to resolve the pipeline of distressed deals.
For example, the demand for refi nancing previously
matured CMBS loans and future 2012 maturities is
expected to reach $70 billion—far above estimates
of CMBS new-issue origination. Even with a fairly
generous estimate that 50% of 2012 CMBS maturing
loans may be able to fully refi nance, the pipeline of
unresolved loans will grow. Surely, many lenders
will be forced to extend loans, but many others may
require some form of modifi cation or disposition. In
particular, nearly $15 billion of maturing CMBS loans
from the 2007 vintage—according to Trepp—could
prove troublesome. These 5-year loans were highly
levered and interest-only; many were underwritten
to weak standards and rents at market peak levels.
The one aspect of the fi nancial markets that will remain
diffi cult to navigate will be the prospect of continued
volatility and uncertainty related to the European debt crisis.
This will require additional patience and fl exibility on the
part of lenders, as borrowers are likely to pause frequently
to re-evaluate strategies and bids in light of volatile capital
markets. In addition, the heightened competition between
life companies and banks for the best quality deals in the
primary markets is likely to remain in place. Risk aversion
will remain an important theme among fi rst mortgage
lenders in 2012, creating opportunities for mezzanine
lenders that provide gap refi nancing, as well as those that
seek to re-fi nance deals in secondary markets.
Several trends would seem to indicate that the debt markets
are moving past a period characterized by distress, to an
era where re-capitalization is the dominant theme. A recent
plateau in CMBS and bank commercial loan delinquencies,
sales of several international banks’ distressed U.S. lending
portfolios, the gradual resolution of construction and
development loan problems, and faster CMBS resolutions
would seem to indicate that a period of peak distress
may soon pass. Meanwhile, a modest recovery in values
would indicate that borrowers and lenders are increasingly
focused on re-capitalizing performing deals. However,
it appears that 2012 will be yet another transition year
for real estate debt capital markets. With only modest
improvement in market rents and occupancies expected,
45
40
35
30
25
20
15
5
10
0
2009
2013
2011
Source: CBRE Econometric Advisors.
Single-Tenant Construction Returns First HistoricallyMulti-Tenant, Vacancy Rate, %
Single-Tenant Share
Multi-Tenant Vacancy Rate, % Single-Tenant Construction as a Share of Total %
25
20
15
10
5
0
1985
1993
1995
1987
2001
2003
1997
1999
1989
1991
2005
2007
highly leveraged loans and development deals are likely
to remain under a signifi cant amount of pressure, which
may result in the continuation of high loan delinquencies,
especially among CMBS issuers and banks.
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situation is such that will never see major new construction
over the life of the target holding periods of many funds.
The fact is that there are a number of potential construction
projects out there which might return quickly.
Over the years, an economy demands new construction.
Firms grow and need to consolidate operations into a single
location. Tastes and technologies change, and fi rms want
to consolidate into open fl oor-plans or LEED buildings.
Even in high-vacancy markets, such changing patterns of
tenant demand can lead to new construction. In the Dallas
offi ce market for instance, even with vacancy rates in the
low 20 percent range in the four years from 2006 to 2009,
construction averaged 2.7 million square feet per year. The
high vacancy was focused on assets that were functionally
obsolete and new construction was needed to facilitate the
demands of tenants in a growing economy.
Still, tenant demand alone is insuffi cient to drive major
new construction. The fi nancial markets are the issue
today, with speculative development problematic, given
a lack of easily accessible capital to bring these projects
to conclusion. Among investors, there has been a move
toward risk aversion; this is especially true of lenders. This
is not the same as saying that there is no capital available
for development; in fact, fi rms that might otherwise be
tenants in commercial properties might in the end opt out
of the rental market altogether.
As shown in the preceding chart, the share of all offi ce
construction that is purpose-built for single-tenants tends to
rise when the market is otherwise facing slack conditions.
When vacancy was high in the mid-1990s, the early
2000s and in this recent downturn, new construction was
shutting down and the share of new construction that was
purpose-built, single-tenant space was rising. When the
development market shuts down, the corporate tenants
who need new space will need to step up to the plate and
take on more fi nancial responsibility for the space needed
for their operations.
The one period for which this relationship does not hold is
in the period from 1985 to 1992, when vacancy was very
high and single-tenant construction was low. In that time
Source: CBRE Econometric Advisors, Real Capital Analytics, November 2011
The Inventory of Failed Developments Valued $100 Million and Greater Might Come Back from the Dead
“Value” Square Feet x 1,000 Units No. of Projects RCA Sales 2011
Total Apartments 129,208,548,469 1.8 849,091 548 41,733,328,214
Hotel 50,954,310,621 22,789 230 16,764,794,592
Offi ce 112,084,652,513 456,154 444 47,806,932,109
Retail 76,500,860,668 428,534 379 33,355,959,515
Warehouse 12,356,392,682 203,303 65 23,118,055,411
Abandoned Apartments 73,002,614,560 479,735 281 41,733,328,214
Hotel 25,961,451,002 113,512 105 16,764,794,592
Offi ce 49,003,727,698 199,432 198 47,806,932,109
Retail 47,217,655,107 264,499 220 33,355,959,515
Warehouse 6,194,322,444 101,917 30 23,118,055,411
Deferred Apartments 56,205,933,908 369,356 267 41,733,328,214
Hotel 24,992,859,619 109,277 125 16,764,794,592
Offi ce 63,080,924,816 256,722 246 47,806,932,109
Retail 29,283,205,562 164,036 159 33,355,959,515
Warehouse 6,162,070,237 101,386 35 23,118,055,411
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frame, fi rms looking for new space would have needed
a compelling reason to allocate capital to purpose-built
facilities when developers were still building and in some
cases practically giving away the properties for free.
By contrast, with developers and lenders in the current
market so risk averse and hesitant to commit capital to new
construction, corporations may end up committing capital to
such projects. Many corporations are carrying heavy cash
balances on their books, and some may opt to put some of
this capital to work in purpose-built single-tenant projects.
If fi rms opt to pursue this path, their ability to undertake new
single-tenant projects will be aided by the sheer inventory of
failed development projects that currently litter the market.
The preceding table, drawn from our CBRE EA/Dodge
Pipeline report, highlights the fact that there is a substantial
inventory of failed major development projects that never
reached completion during the recent market boom. These
projects include many for which entitlements are already in
place and only a source of capital is needed to bring them
back from the dead, so to speak.
To compile the list, we estimated a current “value” for each
project, using the product of the inventory of space or units
in the project and the average national sales price for assets
built since 2000, according to sales data published by Real
Capital Analytics. Included in the table are those projects
that were either abandoned or deferred in recent years and
came in at $100 million or greater.
In the offi ce sector so far in 2011, there were about 30%
more projects deferred—i.e., put on hold until conditions
improve—than there were office buildings sold. The
potential overhang is even greater in the hotel sector, where
deferments were roughly 50% higher than all transactions
through November of 2011. Warehouses are relatively
under-represented here, owing to the short lead times
needed for construction.
Faced with mounting costs and limited sources of
construction and fi nancing, the developers behind some of
these failed projects will either default outright or reduce
their stakes by bringing on other capital partners—if the
market works properly. As the interests in these projects
trade hands, one investor will be taking a loss and the actual
input cost of the development will be falling for that next
investor. History shows us that funny things can happen
when the commercial property markets come out of an
extended downturn, and relative prices change.
Our CBRE colleagues in Tokyo tell us of what was termed,
“The 2003 Problem”—when, after years of unwinding
some of the excesses from the 1980s’ property bubble, the
massive reduction in land costs made development projects
fi nancially feasible, even if market vacancy and new tenant
demand were not calling for construction. The development
boom that ensued added roughly 12 million square feet to
the 23 wards of Central Tokyo in a single year. Again, the
market itself did not need the space; tenants were simply
moved from one building to another as new investors ended
up with old development sites at a lower going-in cost. As
investors pursue yield in the U.S. today, does the market
here face a similar risk?
Our $100 million cutoff for the list above was not just an
attempt to refl ect the large projects that a single corporate
tenant might take on for its own use. Given that investors
are still hungry for yield in the current market and that there
is some new tenant demand, some of what happened in
Tokyo could happen in the U.S. While this would not likely
be to the same degree as in Tokyo—where the stock of
offi ce space grew 6% in a single year (“normal” growth was
closer to 2-3%)—there is the risk that, as failed development
projects trade hands, the reduction in development costs
will allow new projects to move forward, despite the dearth
of construction lending.
Many investors are counting on the fact that the current
shutdown of new competitive supply will help to boost
property income in the short term. Again, we agree with
that thinking, and the forecasts presented in our Outlook
platform hold to this view over the next year or two.
However, over a more extended period—one typical of the
holding periods for most funds in the U.S.—this convergence
of views erodes. Some investors are making investments
today, thinking that no new construction will come in over
fi ve- or even ten-year horizons. These assumptions cannot
hold over such a time horizon, given the sheer quantity of
failed development projects out there. At some price-point,
these projects will trade hands—such that the new owners
will not need construction fi nancing to move forward.
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with retailers remaining circumspect about the consumer
recovery.
The impact of the recent recession on retail sales is apparent
when current levels are compared to pre-recession levels—
particularly for the housing-related sales segments. All
of the three major retail sales categories—necessities,
housing-related and discretionary—declined in 2009
as consumers curtailed their spending. With consumers
least likely to dramatically alter their spending on daily
necessities, that category is the most stable; it wasn’t
immune, however, and necessity-based spending dropped
in 2008Q4 and 2009Q1. Drops were more substantial
in discretionary sales (which, in 2009Q2, was down 11%
from its 2007Q4 peak) and housing-related sales (which,
in 2009Q4, was down 35% from its 2006Q1 peak).
All of the retail sales categories have passed their troughs
and have begun to recover. Having experienced a less
severe drop, necessity spending returned to expansion at
the end of 2009, and as of the third quarter of 2011, the
discretionary sales category has begun expanding as well.
The housing-related sales sector has been recovering, but
at a slightly rocky pace, and sales remain 19% below their
previous peak. With consumers still unsure about the future
of housing values, they seem unwilling to invest in their
houses at the pace they did prior to the housing crisis. Don’t
expect the sector to regain its previous peak within the next
several quarters; consumers won’t be fi lling new houses with
big ticket housing-related items in 2012. That said, recent
spending increases in private residential construction are
concentrated in renovations and improvements (according
Source: CBRE Econometric Advisors.
Availability Rates Stabilizing in 2011
Lifestyle & MallN&C&SPowerChange in Availability (%)
1.4
1.2
0.8
0.2
0.4
0.6
1.0
0.0
-0.2
-0.4
-0.6
2006
.1
2007
.120
07.2
2009
.1
2006
.2
2008
.120
08.2
2009
.3
2007
.320
07.4
2009
.2
2006
.320
06.4
2008
.320
08.4
2009
.420
10.1
2010
.220
10.3
2010
.420
11.1
2011
.220
11.3
Source: CBRE Econometric Advisors.
All Retail Sales Segments Expanding, Except for Housing
RecessionHousing
DiscretionaryNecessities
Index, 2004 Q1 = 100
140
130
110
90
120
80
70
100
60
2000
.1
2002
.120
02.3
2006
.1
2000
.3
2004
.120
04.3
2007
.1
2003
.120
03.3
2006
.3
2001
.120
01.3
2005
.120
05.3
2007
.320
08.1
2008
.320
09.1
2009
.320
10.1
2010
.320
11.1
2011
.3
TREND #9RETAIL RENTS FINALLY SEE BOTTOMLagging Behind Other Property Types, Last Pieces Fall in Place
The recent recession’s impact on the retail industry was
deep and lasting. Retail sales suffered as consumers pulled
back on their spending to focus mainly on purchases of
necessity goods. For retail centers, this translated into
historic absorption drops and availability rate increases,
and no center seemed immune. The retail demand recovery
was slow to begin and has had a rocky start, but it has
begun. Availability rates stabilized in 2011, but there is
still a long way to go to reverse the damage done by the
recession. With the demand recovery just getting underway,
we will need to see a couple of quarters of strong decline
in availability rates in order to see upward movement for
rents. Fortunately, such declines are anticipated in 2012,
and in the latter half of the year we expect to see the fi rst
rent growth since the recession began.
Leading up to and during the recent economic downturn,
retail center availability rates increased signifi cantly. As
the housing crisis hit, retail centers saw the fi rst signs
of consumers pulling back on spending; and once the
retailers began to suffer, demand for space began to
decline. Availability rates were increasing by nearly whole
percentage points by 2009Q1. Those increases continued
until consumer spending showed signs of recovery, and
in 2011, availability rates at all three center subtypes
stabilized. Demand momentum has been insuffi cient
to bring a huge downward shift for availability rates,
however, and this lack of momentum will continue in 2012,
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to the Census), and a continuation of this trend should help
to boost sales of building materials and other housing-
related merchandise. It will take a while for housing-related
sales to work their way out of such a deep trough and back
to their pre-housing crisis levels, but it looks like trends
and momentum have them moving in the right direction.
These factors have forced a period of rent declines more
severe than any in our almost 20-year retail history. With
the exception of 2008Q2, retail rents have consistently
declined each quarter since the beginning of 2008, and
are expected to continue on this path for the majority of
2012. This trend’s reversal is anticipated in 2012Q3,
spurred by absorption gaining momentum in 2012 as the
economic recovery becomes more robust. Many retail
center owners have been faced with high availabilities
over the past couple of years, and have been forced to
lower rents in order to gain tenants. In some cases this
has worked to the advantage of retailers; with higher-end
space more affordable than in years past, some have seized
the opportunity to upgrade their space. By the time the
fi nal quarter of rent declines is recorded, rent levels will be
15% below their previous peak and comparable to levels
recorded in 2002q4.
Unfortunately, much ground remains to be made up,
and the rent recovery will not lead to rent expansion until
2016/2017. This was a historic recession for the retail
industry and although the necessity and discretionary
segments have recovered faster than housing-related,
all retail center types shared in the severity of the impact.
With an expected slower and muted demand recovery,
availability rates will remain close to their new peaks in
TREND #10MOVEMENT FROM TRUCKS TO TRAINS WILL BE INCREMENTALRise of Rail Inevitable, but Slow
These past two years saw an impressive fl ow of eye-catching
reports highlighting signifi cant commitments made by both
the federal government and some states to redevelop our
railroad infrastructure. The initiatives are mostly geared
towards improving our passenger train system, not the rail
freight system, with the goal of reducing the overall cost of
commuting in and out of cities.
Some of the investments include the development of
high-speed train systems to be built over the next two
decades across 13 corridors, including Orlando-Tampa
and Chicago-St. Louis. The Federal Government is
expected to provide around $8 billion in funds, most
of it to improve existing services. California has its own
ambitious $42 billion plan (to be partially funded by the
federal government) to connect its major cities through a
high-speed railroad network.
As we move into 2012, the question is whether these
investments will be enough to force a shift from truck
shipment—currently the dominant method of transporting
goods—toward trains, and whether warehouse demand
will be affected at all. The answer is more intricate than
one may suspect and requires several layers of analysis.
The first issue is regulatory. Up until the 1930s,
transshipments in the U.S. relied heavily on trains to move
everything from natural resources to high value-added
merchandise. Beginning in the late 1940s, however,
excessive regulation and the coming of age of the trucking
industry—with bigger trucks running on cheap gas and
door-to-door delivery—undercut the rail industry, bringing
it to its knees by the early 1980s.
The deregulation set forth by the Staggers Rail Act in 1980,
enacted in response to the state of affairs at the time,
Source: CBRE Econometric Advisors.
Rent Growth by 2012Q3
Rent Growth (L)Rent Level (R)Rent Growth, % Rent Level, $
1.5 $21.00
$20.50
$20.00
$19.50
$19.00
$18.50
$18.00
$17.00
$17.50
$16.50
0.5
1.0
0
-1.0
-0.5
-1.5
-2.0
2006
.1
2007
.1
2009
.1
2008
.1
2009
.3
2007
.3
2006
.3
2008
.3
2010
.1
2010
.3
2012
.1
2013
.1
2011
.1
2012
.3
2013
.3
2011
.3
Lowest Rent Since 2002Q4, Down 15% from 08Q1 Peak
2012, declining only slightly. Retail center owners will gain
some leverage by mid-2012, and in 2012Q3 we expect
that rents will grow for the fi rst time in four years, and the
retail rent recovery will fi nally be underway.
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the expansion in passenger train demand will likely clog
the transshipment network in most urban centers as well,
worsening existing traffi c conditions in and out of major
markets. In Los Angeles, one of the busiest rail transport
destinations in the country, the Alameda Corridor, an
expressway rail for transshipments only, was completed
in 2002 in order to bypass around 200 grade crossings
(interceptions formed by rail tracks and roads or paths) in
and out of the ports of Long Beach and L.A. This type of
expressway is not the norm, however.
The second question is that of effi ciency. Rail shipments’
great advantage—and their biggest weakness—is size. On
average, one transport train can carry a load equivalent
to that of around 280 trucks. This signifi cantly reduces
the per-unit fi xed cost of transshipments, thus allowing
trains to transport goods with high economies of scale.
The longer the distance that goods are shipped, the lower
the fi xed costs and thus, the more competitive that trains
become. The downside for trains is that other modes of
distribution, such as trucks, are typically more competitive
over short distances.
Concomitantly, trucks are bound by the highway system,
which prioritizes connectivity between cities, not the
brought about a 180 degree turn for the rail transport
industry. The legislation paved the way for consolidations,
allowed owners to drop routes that weren’t profi table, and
enabled them, by and large, to run the system as they
saw fi t, as long as Amtrak continued to have access to the
network. Rail norms were also eliminated for most cargoes,
as long as the shipments could also be transported by road.
Over time, the changes in the regulatory framework led to
signifi cant improvements in productivity among the biggest
operators, increases in return to capital, and consistent
drops in rates for over 20 years. Currently, the U.S. rail
shipment system is considered the best in the world—a fact
not to be taken lightly, given the enormous sums invested
in rail systems overseas. As one would expect, the U.S. rail
system runs through most of our major industrial markets.
The much-needed improvements to our passenger railroad
system, however, could end up hindering the future of
the transshipment rail network, mainly for two reasons.
First, an estimated $15 billion train-control system will
have to be implemented in order to monitor the expected
increase in passenger train traffi c, especially around major
urban centers. Such a regulatory mandate will likely raise
transport rates further, beyond the increases witnessed
since the price of oil began to escalate in 2006. Second,
U.S Railway SystemIndustrial Occupied Stock SqFt
Less than 136,481136,481 - 340,749Greater than 340,749U.S. Railway
Source: U.S. Department of Transportation, Federal Highway Administration, Freight Analysis Framework, version 3.1, 2010.
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The impact of distances travelled is compelling. Trucks
are by and large the chosen mode of transportation for
short-distance deliveries. As distances increase, trains
progressively become the preferred mode of shipments
covering anywhere from 500 to 1,500 miles (to put it in
context, transshipments leaving L.A. would be just short
of St. Louis after 1,500 miles; those leaving Miami would
end up in Boston). Goods transported for more than
1,500 miles are relatively few in terms of tons, moved
mainly by trucks and essentially exclude commodities.
Interestingly, train and truck represent basically the same
proportion (40.2% and 40.1% respectively) of total tons-
miles distributed throughout the U.S., in spite of the fact
that trucks distribute signifi cantly more tons than trains do.
Markets that operate on regional distribution axes for
medium-to-long-range supply routes may witness an
increase in warehouse demand, given ongoing investments,
if two conditions are met: (i) that the price of oil remains
around $100 a barrel and (ii) that improved effi ciency and
capacity in passenger trains increases resident population
Source: U.S. Census Bureau.
Ton-Miles by Mode of Transportation as Percentage of Total
TrainTruck
All Other ModesAverage Train, Truck
T-M by Mode of Transp / T-M by All Modes (%)
100
80
60
40
20
0
Less
than
50
mile
s
50-9
9 m
iles
100-
249
mile
s
250-
499
mile
s
500-
749
mile
s
750-
999
mile
s
1,000
-1,49
9 m
iles
1,500
-2,00
0 m
iles
More
than
2,0
00 m
iles
in and around urban centers. In other words, warehouse
demand will expand if the price of gasoline keeps the cost
of commuting high, and faster, more effi cient trains boost
demographic trends near urban centers.
Finally, we estimated the potential impact on warehouse
demand by looking at the correlations between train and
truck transshipments and occupied warehouse stock. Our
study found the presence of train shipments across major
markets to be signifi cantly correlated with occupied stock
and to be, on average, significantly more correlated
than with trucks. This makes sense: trucks tend to pick
up merchandise from distribution centers—many times
supplied by rail shipments—to make customized deliveries
to individual businesses over relatively short distances.
The ultimate impact of current rail investment on warehouse
demand is still unclear. In the near term, 2012 will not
witness any radical switch in the way we ship goods around
the country. What was delivered by trucks and trains last
year will likely be delivered through the same modes in
2012. Moreover, constrained economic growth next year
will keep overall migration patterns to urban centers in
check. Until this is reversed, demographic trends will
not meet the thresholds in consumer and passenger train
demand necessary to expand, in turn, warehouse demand.
Nonetheless, the secular shift towards urban centers will go
on, albeit slowly, as labor demand in agricultural wanes and
higher wages continue to be made in and around cities. The
switch to trains will not be a matter of if but rather of when.
TREND #11IN SPITE OF CAPITAL MARKET VOLATILITY, FINANCE JOB CUTS TO END BY MID-YEAR 2012Many Finance Sub-categories Have Seen Losses Level Off
Despite steady improvement in occupancies and total
offi ce-using employment growth, the two categories of
offi ce-using jobs produced mixed results in 2011. While
total offi ce-using employment grew by 1% through the
fi rst three quarters, it was mostly due to stronger hiring in
the offi ce-using services category—mainly in companies
providing high-tech and professional and business services,
as fi nancial services providers continued to hand out pink
shortest route between end points. As a result, trains tend
to travel shorter distances. To capture the difference that
routing imposes, ton-miles—the tonnage transshipped
times the miles it travels—provides a more accurate
measure of transshipments by modes of transportation that
tonnage does. As distances increase, the per-unit cost of
transporting loads by train drops, allowing bigger loads
to be shipped, and vice-versa—shorter distances lead to
increasingly ineffi cient rail shipments.
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slips for the fi fth consecutive year. While offi ce-using services
jobs grew by 1.5%, offi ce-using fi nancial activities jobs fell
by 0.3%. There were many headwinds facing banks and
fi nancial institutions in 2011, which included volatile global
markets amid sovereign rating downgrades (in Europe
and the U.S.), a sluggish domestic housing recovery and
regulatory changes from the Dodd-Frank Act. Will these
events of 2011 continue to affect hiring trends at fi nancial
fi rms in 2012? Or will improvements in the domestic
economy be enough to fi nally halt job losses for the sector,
irrespective of global uncertainty and regulatory changes?
Despite downside risks from Europe, the U.S. domestic
economic expansion should continue in 2012, helping
payroll expansion in the more cyclical employment
categories of fi nance like Real Estate, Credit Intermediation
and Insurance. Total credit growth (for both businesses and
consumers) has improved since April of 2011, and future
improvements in home sales activity should be a boon for
real estate lenders and brokers, as well as home insurers.
Real Estate employment, which accounts for 20% of total
fi nancial activities employment, will slightly outperform
the rest of the subcategories of fi nance in 2012. The other
subcategories’ respective shares are as follows: Credit
Intermediation and Related Activities—36%, Securities,
Commodity Contracts and other Financial Investment and
Related Activities—12%, Insurance Carriers and Related
Activities—31%, and Funds, Trusts and Other Financial
Employment—1%.
By some estimates, global job cuts in the fi nancial services
totaled over 200,0001 in 2011. Though Europe was the
hardest hit region, layoffs were announced at U.S. banks
as well, and include the likes of Goldman Sachs, Citigroup,
Bank of America and Morgan Stanley. Q3 2011 results for
large investment banks were the worst since the subprime
crisis, as revenues fell due to cutbacks in proprietary
trading and capital-raising activity. Fortunately for offi ce
investors though, this hasn’t resulted in announcements of
banks shedding space, as took place in 2008 and 2009.
In December more cuts were announced at Citigroup
(4,500) and Morgan Stanley (1,600), though, with eventual
reductions to occur in 2012.
Despite a sour year in terms of revenue, we expect payroll
cuts at fi nancial fi rms to be nearing an end. Even with the
recent announcements, the rate of decline for offi ce-using
fi nancial activities employment has eased since 2009. We
expect year-on-year job growth for offi ce-using fi nancial
activities to begin in the second half of 2012. The sector will
continue to underperform offi ce-using services, however,
with annual growth of only 1.4% in 2012, compared to
2.6% for services.
Even if job growth at fi nancial services fi rms disappoints
in 2012 as it did in 2011, investors can take solace from
the fact that offi ce markets have been able to adjust
to a long-term trend of the financial services sector
underperforming the offi ce-using services sector. For the
Source: CBRE Econometric Advisors, Economy.com.
Despite Recent Announcements, Financial Job Cuts are Nearing an End
Credit Intermediation & Related ActivitiesSecurities, Commodity Contracts & Other Financial Investments and Related Activities
Funds , Trusts & Other Financial EmploymentInsurance Carriers & Related Activities
Real Estate
Subcategories of Financial Activities Employment, YoY % Change54
2
-2
-4
-6-7
-1
1
3
0
-3
-5
-8
2007
Q1
2009
Q1
2009
Q3
2007
Q3
2011
Q1
2011
Q3
2010
Q1
2010
Q3
2008
Q1
2008
Q3
2012
Q1
2012
Q3
Source: CBRE Econometric Advisors.
In 2012, Finance to Underperform Services Again
Offi ce -Using ServicesOffi ce-Using Financial ActivitiesOffi ce Job Growth, YoY % Change
6
2
4
0
-2
-4
-6
-8
2007
.1
2009
.1
2009
.3
2007
.3
2011
.1
2013
.1
2011
.3
2013
.3
2010
.1
2010
.3
2008
.1
2008
.3
2012
.1
2014
.1
2012
.3
2014
.3
1 http://www.bloomberg.com/news/2011-11-22/wall-street-unoccupied-with-200-000-job-cuts.html#
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All is not lost for fi nance, however! Banks and investment
fi rms will continue to play a signifi cant role in many markets
and submarkets, especially as the economy gains strength
and the need for fi nancial intermediation picks up speed.
Although employment in the sector has underperformed
offi ce-using services during the recovery and remains
exposed to both external and internal risks, the more cyclical
subcategories of fi nance should see payroll growth in 2012
and beyond as the overall national economy and housing
market improves.
TREND #12CAP RATE COMPRESSION WILL ENDCap Rates Flat or Worse in the Next Two Years
Over the past five quarters, capitalization rates for
commercial properties in the U.S. have experienced
signifi cant compression across all property sectors. After
their 2010 peak, cap rates have seen a steady downward
trend during this period, driven by a recovery in portfolio
values. The value growth of these last fi ve quarters has led
many investors to hope that, rather than being a simple
correction, this bounce represents a driver of future asset
value increases.
We argue that this optimistic view is incorrect, and that the
cap rate compression (and the attendant growth in values
stemming from it) has come to an end. Furthermore, we
argue that cap rates will remain fl at for the next two to three
years, and that there is even a risk of a modest increase in
cap rates in certain markets and sectors.
Why would we take such a position, especially in view of
the continuing low interest rate environment? It boils down
to the expected behavior of the fundamental factors that
drive asset pricing, over the next three years. Let’s consider
these one at a time, starting with rental income.
As the chart below shows, Net Operating Incomes (NOIs)
are expected to either remain fl at or drop slightly in the
next three years, under our base case scenario. This weak
performance will be driven by continued weakness in many
Source: CBRE Econometric Advisors.
Signifi cance of Finance Has Eased Over the Years
199020002010Financial Activities as % of Total Offi ce-Using Employment
45
40
30
20
25
35
15
10
5
0New York Boston San
FranciscoLos
Ange-Chicago Philadelphia Sum of
Markets
Source: CBRE Econometric Advisors, NCREIF.
NCREIF Cap Rate Forecast
NCREIF Cap Rate %
12
11
9
6
4
8
10
7
5
3
2
1999
.4
2004
.4
2006
.1
2014
.4
2001
.1
2009
.4
2011
.1
2007
.2
2008
.3
2002
.2
2003
.3
2012
.2
2013
.3
RetailMultifamily
IndustrialOffi ce
Recession
sum of markets, fi nancial activities’ share of total-offi ce
using employment has fallen from 35% in 1990 to 28% in
2010. This was especially evident in large markets that are
considered to be fi nancial hubs, such as New York, Boston
and San Francisco. Headcounts in total fi nancial services
for New York and San Francisco are 11% and 23% lower
than they were in 1990. Technological innovation, bank
consolidation and shifting of back-offi ce jobs to smaller
markets have meant that fi nancial sector employment and
its share of total offi ce-using employment have declined
even in markets considered to be financial hubs. Yet
offi ce occupancies have continued to grow there, as fi rms
providing high-tech and professional and business services
have played a more signifi cant role in hiring and in leasing
offi ce space. In 2011, many of the largest leases signed in
New York, San Francisco and Boston were from industries
other than financial services—software companies,
healthcare and consulting fi rms among them—and the
same can be expected in 2012 and beyond.
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While we do not forecast a drop in rents and increases
in vacancies for a majority of markets (rather, we expect
slow recovery, with the speed of the bounceback varying by
property sector and market), the lease rollover effect will be
strong enough in many cases to depress NOI performance
for the next couple of years. As a result, expected rental
income—one of the fundamental drivers of asset pricing—
will likely remain weak on average in the next three years
(with the notable exception of multifamily, which will have
a stronger recovery).
While weak rental fundamentals will play a role in the
end of cap rate compression, the primary drivers of asset
valuation will be capital market effects. On the positive
side of asset pricing, we expect interest rates to remain low
over the next three years. Given current uncertainty around
the fallout from the Euro Zone crisis and the slow pace of
economic recovery, the Fed is likely to continue its current
accommodative monetary policy during this period. This
low interest rate environment will prevent cap rates from
rising signifi cantly, even in spite of uncertainty around the
capital markets.
This capital markets uncertainty, however, will likely
manifest itself in other ways. One such manifestation will
likely be subdued risk appetite on the part of investors
(and the degree of risk aversion is known to be a strong
factor in asset pricing). Corporate bond spreads over U.S.
Treasurys—one metric that measures risk aversion—remain
high by historic norms and are expected to remain high,
under our base case scenario. As a result, further increases
in asset values (and hence, drops in cap rates) are fi ghting
against investors’ fl ight to assets that are safer than real
estate. It could even be argued that high risk premiums
could cause cap rates to perk up higher, depending on
the exact interplay between the interest rate effects, risk
aversion, and capital availability. This could happen and we
explore its implications under our fi nancial crisis scenario,
which calls for a severe shock from Europe (although not
a complete disintegration of the Euro Zone), constraining
capital markets, denting economic growth and causing a
temporary upward adjustment in cap rates.
Another way to look at this phenomenon is to view
commercial real estate in context of other markets—most
notably, the rest of fi xed income instruments. As spreads
on other asset classes begin to widen again in response to
the investors’ renewed worry about medium-term prospects
for the economy, even high quality “core” real estate assets
will not be immune to the adjustment of expectations by
investors.
The third major capital markets effect that we expect will
have a negative impact on asset pricing is credit availability.
Credit availability was severely affected during the fi nancial
crisis. There has been signifi cant recovery in debt since
then, but the economy as a whole is still deleveraging.
Our research indicates that debt availability is one of the
strongest factors in determining asset pricing, and, as a
result, the expected path of recovery in debt availability
in the next three years will be instrumental in determining
the behavior of asset prices and cap rates during that
period. We expect a relatively slow recovery in leverage in
the economy, which will contribute to the end of cap rate
compression (and a possible temporary cap rate reversion)
in 2012.
While our short-term outlook calls for lackluster performance
of commercial real estate, our medium-term view is more
positive. We forecast that commercial real estate will deliver
decent returns in the 5-year period, comparing favorably to
most other investment alternatives. A large portion of that
return will come from income returns, since appreciation
returns will either not contribute to, or subtract from, the
total return metric in the next two years. Subsequently,
values will start to recover, contributing to investment
2013
.3
Source: CBRE Econometric Advisors, NCREIF.
Net Operating Income Index: History and Forecast
RetailMultifamily
IndustrialOffi ce
Recession1997 Q4 = 100%
180%
160%
130%
110%
150%
170%
140%
120%
100%
90%
1999
.4
2004
.4
2006
.1
2001
.1
2009
.4
2011
.1
2007
.2
2008
.3
2002
.2
2003
.3
2012
.2
rental markets and property types, and by the expiration
of leases signed at higher rates between 2006 and 2008,
replaced with leases signed at current lower spot rates.
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Source: CBRE Econometric Advisors, NCREIF.
5-Year Average NCREIF Returns: Forecast
Average Return, % History (2011.4 - 2016.4)
20
18
14
10
6
12
16
8
4
2
0Offi ce Industrial Multifamily Retail
Appreciation ReturnYield
Total Return
performance. The bottom line is that while CRE will not post
spectacular results in the short-term, it will still be a viable
investment option, given the expected poor performance
of alternative asset classes.
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Jon SouthardDirector of Forecasting, Econometric Advisors and Director, CBRE Global Research and Consulting+1 617 912 [email protected]
Jim CostelloManaging Director, Americas Research and Director, Global Research and Consulting+1 617 912 [email protected]
Serguei ChervachidzeCapital Markets Economist, Econometric Advisors+1 617 912 [email protected]
Mark GallagherSenior Strategist, Americas Research+1 617 912 [email protected]
Diego IribarrenSenior Economist, Industrial, Econometric Advisors+44 20 7182 [email protected]
Arthur JonesSenior Managing Economist, Offi ceEconometric Advisors+1 617 912 [email protected]
CBRE GLOBAL RESEARCH AND CONSULTING
This was report was prepared by CBRE Econometric Advisors, which forms part of CBRE Global Research and Consulting—a network of preeminent researchers and consultants who collaborate to provide real estate market research, econometric forecasting and consulting solutions to real estate investors and occupiers around the globe.
CBRE Econometric Advisors
CBRE Econometric Advisors (CBRE EA), as part of CBRE’s global research platform, provides commercial real estate research, advisory services and forecasting products to clients. CBRE EA's products and services cover the U.S. and a constantly expanding selection of global regions, as well as all spheres of the real estate market, including public, private, debt and equity.
For more information regarding this report, or to fi nd out more about any aspect of our services, please contact:
Gleb NechayevSenior Managing Economist, Multi-housingEconometric Advisors+1 617 912 [email protected]
Abigail RosenbaumSenior Economist, Hotel and Retail,Econometric Advisors+1 617 912 [email protected]
Umair ShamsEconomist, Offi ceEconometric Advisors+1 617 912 [email protected]
Jared SullivanEconomist, IndustrialEconometric Advisors+1 617 912 [email protected]
Luciana SuranSenior Economist, GlobalEconometric Advisors+1 617 912 [email protected]
Information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt its accuracy, we have not verifi ed it and make no guarantee, warranty or representation about it. It is your responsibility to confi rm independently its accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of CBRE Econometric Advisors.