Recovery in FIRE markets?

On a recent trip to New York, I had the opportunity to have a conversation with Deidre Bolton of Bloomberg Television about Colliers’ outlook on commercial real estate.

One of the major trends we touched on is the unevenness of the office market recovery. Colliers Research has observed for over a year that the strongest performers (in terms of job creation and office vacancy rates) have been what we call “ICEE” markets: those with an employment profile that strongly favors intellectual capital, energy and education, rather than markets traditionally associated with “FIRE” (financial, insurance and real estate) employment.

Recently, we've started to see the traditional FIRE markets catching up: FIRE absorption climbed to 73% of the ICEE total, up from 44% in 1H 2013; this counter-trend is supported in the October employment numbers.

But a closer look reveals an interesting fact: Most of the absorption in FIRE markets comes from submarkets with an ICEE profile. Submarkets such as West Los Angeles, New York – Midtown South, Chandler, AZ, and even Downtown Las Vegas are notable clusters of technology employment. Several Atlanta submarkets, allied with top universities and research institutions, are part of Atlanta’s transition from FIRE to ICEE.

The newly released North American Office Highlights report will takes a deeper dive into this topic, and includes a list of key submarkets to watch that are outperforming (or are poised to outperform) the metro areas in which they’re located.

What's driving cap rate compression?

After a recent client event in New York, I spent some time discussing the markets with KC Conway, chief economist in the U.S. for Colliers. It turns out we’re hearing the same question come up pretty frequently: What’s going on with cap rate compression? (KC has been having similar conversations regarding cap rates with bank regulators.)

Over the past 24 months, U.S. capitalization rates for all income-producing property types have declined to levels never seen before. Rate compression has been most pronounced in multifamily and credit-tenant, net-leased properties, where rates have dipped below 4.0%. Cap rate compression has been slower to occur in industrial real estate; however, that’s changing rapidly as investors rotate out of multifamily, and look to invest in the re-making of America’s supply-chain in response to growth in e-commerce and the Panama Canal expansion.

The Historical Perspective

As this graphic shows, we’re clearly in uncharted waters. The long-term average cap rate between 1965 and 2010 was 9.5%. After dropping to nearly 6.0% prior to the onset of the 2007-2009 financial crisis, cap rates rose sharply between 2008 and 2010 to 8.5%. This increase, around 200 basis points, eliminated approximately 25 percent of commercial real estate values. During the recession, increasing vacancy rates and declining rents caused another 20 percent decline in values, as indicated by the Moody’s Commercial Property Price Index (CPPI).

Source: American Council of Life Insurers.

All told, roughly 45 percent of the value of commercial real estate was wiped out from 2008 to 2010. But less than three years after the “Great Recession,” commercial real estate values have rebounded. Institutional capital and commercial real estate investors are pursuing income-producing real estate again, and have bid average cap rates to a new historic low: under 6%. Why; and what is behind this trend?

Many ascribe the trend to institutional investors’ ongoing search for yield, but of equal import is investor anxiety over Federal Reserve monetary policy aimed at devaluing the U.S. dollar and re-inflating asset prices out of the risk curve. With a 10-Year Treasury yield around 1.8% and inflation near 2%, commercial real estate certainly seems more attractive--even at a historically low 4% to 5% cap rate.

What about equities or stocks? Here commercial real estate is increasingly attractive because of its relative stability. With most major U.S. stock indices at near-record highs, and the volatility in electronic trading that can move equity prices by as much as 5% in a single day, commercial real estate is a consistent way to attain cash-on-cash yield above 4% (and as high as 7% or 7.5% in secondary markets) without the daily fluctuation in asset price.

But there could be more to this trend than just a search for yield. The approaching retirement of millions of baby-boomers may see investor goals shift toward cash flow and dividends, and away from long-term asset appreciation. Certainly low interest rates have also been a factor. Would multifamily cap rates be in the 4-5% range without cheap Freddie Mac and Fannie Mae debt? 

The question is whether cap rates must necessarily spike as interest rates rise. With so much capital on the sidelines waiting to be invested, could the conventional wisdom of overleveraging--because equity is expensive and debt is cheap--be turned upside down in the next five years? 

Investing from the Ashes

Yesterday I had the opportunity to appear on a very interesting panel at the Bloomberg Commercial Real Estate Conference: “Investing from the Ashes: The Distressed Market.”

The panel examined the investment outlook and areas of both risk and opportunity in distressed real estate. Representing the viewpoint of special servicers was Robert Lieber of C-III Capital, while Billy Macklowe offered the owner’s perspective, focused particularly in New York City.

As was mentioned on the panel, right now the outlook for distress is a mixed bag: We’re at a four-year low for new distress, but there are signs that 2013 volume will increase. CMBS loans remain the largest share of outstanding distress, and there’s another major wave of delinquency in the future as the 10-year loans from 2005-7 mature.

We see the next generation of opportunity is in secondary markets, where population growth and fundamentals (housing, job growth, etc.) are starting to rebound. In some cases like Tampa and Memphis, these markets are early beneficiaries of the shift in global trade patterns and changes in our logistics network in anticipation of the 2015 Panama Canal expansion. We also see industrial property as a stable asset class, with the least exposure from CMBS distress.

From our perspective, the greatest market risk is from interest rate sensitivity. A rise of 200 basis points in interest rates over the next two years—below the long-term trend—could, by our estimation, potentially add 20 to 25 percent new distress to the market. The hope, of course, is that interest rates would be rising in response to other positives in the economy as a whole, but it’s nonetheless a major risk for investors in the distressed space.

I very much enjoyed the opportunity to participate, and hear the perspectives of our peers in the market. Thanks to Beth Jinks and Bloomberg News for making it possible.

Here is a link to the video: http://bloom.bg/PShonm

Colliers Again Named an Outsourcing Leader

Colliers International has again been named to the International Association of Outsourcing Professionals® 2012 Global Outsourcing 100® service providers list. 

Every year, IAOP recognizes the best outsourcing firms across multiple industries, as selected by an independent judging panel. This is the seventh consecutive year that Colliers has been honored with this distinction. The Global Outsourcing 100 is more than just a ranking--it is a critically important resource for any company seeking best-in-class service providers and vendors.

The complete list will be unveiled by IAOP on July 23. You can view the 2011 results here. 

Thanks to all of our professionals and staff for once again establishing Colliers as a leading global real estate services provider.

Dollar Days

The newly released white paper “Dollar Days: How Dollar Stores Are Growing a Weak Economy” documents a strong national trend in consumer behavior and its impact on retail leasing. The report, by Ann Natunewicz (head of research for Colliers Retail Services Group), traces the recent aggressive expansion and repositioning campaigns of the four major dollar store chains.

What’s driving the growth of dollar stores?
Obviously, economic conditions have severely impacted consumer behavior, both in terms of disposable income and perception of “value.” Dollar store chains have expanded food offerings, rethought their merchandising strategies, and targeted a higher-end mainstream consumer.

How significant is this trend?
The four largest chains—Dollar General, Dollar Tree, Family Dollar and 99¢ Only—now operate roughly 21,500 U.S. locations. By contrast, the three largest drug store chains combined have only 19,700 locations.

What’s more, dollar stores continue to capitalize on the availability of better space, in terms of demographics, location and footprint. At first, this trend was fueled by recessionary vacancy rates and depressed leasing markets; however, this growth has persisted even in markets that have seen significant recovery in rents and absorption. Growing interest on the part of landlords and property investors indicates that dollar stores have become a more desirable destination, and are favorably impacting traffic and vacancy rates in the shopping centers they occupy.

What does this mean for retail leasing?
Aggressive expansion and larger footprints will continue to drive absorption, even in markets where pricing has normalized, or traditional grocery and drug stores are still prominent.

Dollar store chains will still be able to dictate aggressive terms. Landlords recognize that the dollar store value proposition is part of the “new normal” for consumers, and are attracting a higher-ticket demographic. And, as dollar stores increase their food offering, they drive a higher trip frequency. For smaller regional centers with a local tenant mix, a dollar store can also provide a national-level tenant opportunity.

Where can I find out more?

Download a PDF copy of “Dollar Days: How Dollar Stores Are Growing a Weak Economy” here.

Colliers International Launches Government Services Practice Group

I'm excited to report that the senior team of Kurt Stout, Charles Dilks, and Keith Lavey have joined the Colliers International to lead our newly established Government Services Practice Group.

Based in Washington, D.C., the six-member team will provide a full array of consulting and contracting services to government agencies on a national basis. These Colliers professionals represent private sector landlords who lease space to government tenants. They also participate in the sale of government-leased properties.

“Colliers International is a perfect cultural fit for our team. This is a unique opportunity to establish a national business unit that is exclusively devoted to providing real estate services to government agencies as well as investors who serve government tenants,” said Stout, a 20-year real estate veteran in the government services sector.

Last week, Colliers International also announced a major expansion of its Washington, D.C.-area operations with the launch of a new office in Northern Virginia and the introduction of a regional property management practice.