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"You're going to see minimal, minimal positive absorption over the next 12 to 18 months, maybe 24 months," said Joseph Sciolla, a principal at CRESA Partners LLC, a Boston-based real estate firm. "There isn't any reason that rents are going to go up." "By the end of 2001, we had calculated that the Class A average was $55 a square foot and Class B was $36 a square foot. As we approach midyear (2002), those numbers have dropped by at least 10 percent and are likely to drop another 5 percent by year's end," said Ted Wheatley, a senior vice president in the local office of Dallas-based Staubach Co. Some landlords are getting aggressive, chasing after tenants in the market with flexible rates, free rent and tenant- improvement packages in bids to land a secure, high-profile tenant for a long-term lease. But other landlords appear to be balking at the prospect of dropping rents significantly in order to ensure they hold onto an existing tenant or sign a new one. With expectations that Boston's office leasing market will pick up sometime in 2003 or 2004 - about the same time that a wave of large leases will expire - landlords appear to be splitting into two camps. Staubach's Wheatley, however, said that even with Class A rents dropping to around $50 a square foot, rates are close to 1998 levels, before they began their meteoric rise. "Landlords still have enough net profit above tax and operating expenses to meet their debt service and yield requirements," Wheatley said. "It's really a case of which landlord blinks first."
Rouse is embracing the future of retail real estate like few in its field. It is pouring money into major regional malls with high-end anchors. This month, Rouse closed its largest acquisition ever -- the $1.45 billion purchase of eight affluent malls from North Carolina to Texas. Later this year, Rouse will open and expand malls in South Florida and Las Vegas, anchored by highbrow stores such as Neiman Marcus, Nordstrom and Bloomingdale's. But the value of many of Rouse's older, once-innovative projects is becoming more sentimental than real. A string of vacant storefronts persists in some of Rouse's former retail jewels. The company is facing a thorny issue related to its longevity: The very projects that made Rouse a national player in the 1960s, 1970s and 1980s, many of them conceived by visionary founder James W. Rouse, are now some of its most troubled holdings. Rouse remains profitable but not immune from the economic downturn. For 2001, it earned $110.7 million, down from a profit of $170.5 million the previous year. Revenue declined in its three business lines: retail centers, office and other properties, and community development. Some analysts are particularly troubled about what they call Rouse's "festival marketplaces," large city retail centers such as Miami's Bayside Marketplace, New York's South Street Seaport and Baltimore's Harborplace, which depend heavily on tourists. Many of these projects were personally overseen by James Rouse when he was chief executive. Further complicating matters, many of these locations, such as Harborplace, are integral to the economic health of downtown areas. Some of the properties have proved to be a financial challenge for Rouse, and one that the company may not be able to maneuver out of easily, said David M. Fick, a real estate analyst at Legg Mason Wood Walker Inc. of Baltimore. "A big shopping center is still the center of the community. The shoppers are very loyal. Having that vitality in the changing retail environment is what's critical for us" says Rouse chief executive Anthony W. Deering. It is also critical for the stores themselves to adapt to the current market, said Louis W. Taylor, an analyst at Deutsche Bank in New York. "They key for all those tenants is, do they have a competitive product, do they have a competitive niche?" Taylor said. "They have to decide if they pay higher rent in malls, or are they better off in a community center with lower costs and potentially lower sales. It's usually the toughest decision they have to make. It's part of what makes retail so tricky." Year-over-Year FFO per Share Growth for Real Estate Stocks National Association of Real Estate Investment Trusts (NAREIT) 5-23-02
FFO per share for all equity REITs and other non-REIT publicly traded real estate companies combined declined .3% on average in the first quarter, including a 34% decline in average FFO per share for the lodging/resorts sector. When lodging/resort companies are removed, FFO per share grew 4.6%. Earnings for most real estate companies fared better than other sectors of corporate America. According to First Call,earnings growth for the 482 companies from the S&P 500 (96%) that have reported earnings so far for the quarter declined 12%. Approximately 80 percent of the companies tracked by industry analysts met or exceeded their consensus FFO per share estimates for the first quarter. Forty eight percent of the companies exceeded their expected level of FFO per share, while another 31% of the companies met their consensus estimates.
But that insulation has been quickly deteriorating as fewer leases are being renewed and those that are have substantially lower rates. And this is raising the likelihood that credit squeezes and other problems will mount for many office-building owners for the remainder of the year. Despite signs that the overall economy is recovering, rents are falling in practically every market in the country. Moreover, many landlords are now beginning to see their cash flows - revenue minus expenses, before debt service - decline for the first time since the recession began. Because apartment leases typically are for much shorter terms than office leases, they are hit sooner by declines in market rents. According to the Reis indexes, average cash flows of apartment buildings began declining in last year's third quarter. But the same wasn't true for office buildings until this year. Average cash flows stayed flat or increased slightly throughout last year. But with above-market leases beginning to burn off, cash flow dropped 0.8% in the first quarter of 2002, according to Reis. In the first quarter alone, San Francisco had a 10.9% decline in effective rents. Landlords also were hard hit in Denver, Seattle, Austin, Texas, and Portland, Ore., where average cash flows dropped 3% to 3.5%. In the early '90s, sharp increases in vacancy rates coupled with dizzying drops in rents and cash flows had forced thousands of properties into foreclosures, bankruptcies, debt restructurings and sales at steep discounts. In Q1-02, the delinquency rate of the $22 billion in office loans tracked by Standard & Poor's was 0.94%, far below the double-digit rate of the early 1990s. But the first-quarter rate was still nearly double the 0.49% rate of Q4-01.
"Single-family home sales are still strong, we're seeing a continuation of new apartment supply into a weakened market, and we're still seeing very tepid, if any, employment growth - those three things combined make for a less-than-glowing outlook for the apartment sector," says Craig Leupold, analyst at Green Street Advisors. People in their 20s have been entering the home-buying market much earlier than previous generations. Minorities, who traditionally rent housing for longer periods of time, are buying homes earlier, too, thanks to lower down payments. Should interest rates rise, of course, so, too, could demand for apartments. Meanwhile, demographic trends are expected to play in the apartment market's favor. So-called echo boomers - baby boomers' children - will soon be the age where they are ready to become potential apartment renters. "Down the line, there will be this huge wave of young renters, which makes the outlook over the next two-to-three years very strong," says Greg Willett, director of research products MP/F Research Inc., an apartment-sector consulting firm based in Dallas. The immigrant population - traditional renters of apartments, at least when they first arrive in the U.S. - is expected to continue growing, says Mark Zandi, chief economist at Economy.com. The number of legal foreign immigrants has been steadily rising each decade - about 10 million individuals in 2000, from about nine million in the 1990s and about seven million in the 1980s. The supply front also looks a little better for the industry. The number of apartment units, including co-ops and condos, completed in 2001 was 281,000, down from 304,700 in 2000, according to new Census Bureau figures. "We will continue to see construction at lower levels," says Mark Obrinsky, chief economist at the National Multi Housing Council. They may want to ratchet down supply a bit more: Reis forecasts that the apartment-vacancy rate will keep increasing until 2005.
Meanwhile, the correlation between REITs and large-company stocks fell 61 percent and recently stood at 25 percent. For bonds, the correlation is even lower: It fell 41 percent and recently stood at 16 percent. The study also looked at how REITs could have reduced portfolio risk over time. Ibbotson found that a portfolio of 40% bonds, 50% stocks and 10% Treasury bills would have delivered an average annual return of 11.8 percent, and a risk level of 11.2 percent during the years from 1972 through 2000. By contrast, a portfolio of 35% bonds, 45% stocks, 10% Treasury bills and 10% REITs would have gained 12 percent annually with a risk level of 10.9 percent -- a higher return at lower risk-during the same period. In short, a modest dose of REITs boosted the investment return by almost half a percentage point, while reducing the portfolio's volatility.
Pomroy says commercial landlords will have a tough time raising rent if the economy stays sluggish, and any gains will have to come from cost savings. Those savings may be hard to achieve, though, since REITs already operate more efficiently than they did three years ago. Richard Band, editor of Profitable Investing, just scaled back the REIT holdings in his model portfolio from 10% to 5%. Band is selling AMB Property Trust , BRE Properties , Chateau Communities , Equity Office Properties and Liberty Property Trust. "I suspect that sometime in the next 18 months, we'll be able to buy back most of the REITs that were selling at prices 15%-20% less than today's quotes," Band writes in his May issue.
Moody's probably won't take action until after Memorial Day, but the likelihood of the logjam breaking in Washington before then is low.
What might seem a minor difference in the structure of troubled real estate has major implications for the economy. In the early 1990s, construction all but stopped. And because banks were grappling with billions of dollars in bad construction loans, they were unable to lend for other forms of business investment. "Because the banking system didn't have enough capital, it couldn't make loans to anybody - good credit or bad," said Mark Zandi, chief economist of consulting firm Economy.com. "Commerical real estate was to the last recession what the tech bust has been to this recession." Zandi attributes the "jobless recovery" of the early 1990s - during which companies didn't hire workers back even as business conditions improved - largely to the banks' problems that stemmed from the real estate crash. "Businesses can't expand without credit," he said. What has changed dramatically is the ability of banks and developers to deal with the down market. In the late 1990s, they became much more disciplined in deciding what to build and with what kind of money. For instance, at the peak of the last boom, in 1989, 10% of office development in the Washington area was preleased to tenants. At the peak of the more recent boom, 2000, that level was 52%, according to Delta Associates. The reason for the difference: Bankers and developers learned from their mistakes. In the 1980s, it was common for office buildings to be constructed entirely with debt financing. That meant that when a building didn't bring in as much money as had been expected, developers easily slipped into default. Now, banks almost always require that investors take an ownership stake in a building before making a loan - often as high as 20% - which reduces debt payments and give developers some equity to fall back on if a project gets into trouble. As a result, even in 2001, a down year in real estate, the average return on office investment in the Washington area was 9.7%, compared with a negative return of 2.1% in 1992, according to Delta Associates. Two other differences: (1) Some 32% of the vacant space in the Washington area is sublet, meaning that landlords are still getting paid despite the vacancy, compared with 21% in 1992; and (2) Construction employment, which fell so sharply during the early 1990s, increased 6 percent over the two years ended in March.
Alexandria Real Estate Equities, a biotech REIT, is redeveloping 565,000 square feet of vacant office and warehouse space into laboratory space "that can be leased at higher rates," according to the firm's latest annual report. Hines Interests LP, a Houston-based real-estate developer, recently converted most of a 254,000-square-foot office complex in Redwood City, Calif., to accommodate a biotech firm. And CarrAmerica Realty finalized the purchase Friday of a 78,000-square-foot office building in La Jolla, Calif., with an eye toward converting it to attract a biotech company once the current tenant's lease expires. "As demand for office space has eroded," says Jim Buie, a Hines executive vice president, "we found ourselves needing to look for other users." And unlike rental rates for office space, rents for biotech space "have moved up 10% to 20%" in the San Diego area during the past few years, adds Malcolm O'Donnell, a managing director at CarrAmerica. Scott Morrison, Ernst & Young LLP's national director of the life-science consulting practice, estimates that biotech firms employed about 200,000 people nationwide in 2001. And this year, the sector will post 15% to 20% job growth. Biotech firms typically take 600 to 700 square feet per worker, says Darin Buchalter, a partner at Ernst & Young's real-estate advisory group. Given that, the demand for space from the sector could potentially make a dent in the excess inventory of space in and around markets where biotech firms have clustered.
Trizec also comes to market facing enormous skepticism. Starting about 1998, CEO Peter Munk steered TrizecHahn into a dizzying and, in some cases, disastrous array of investments. Write-downs for TrizecHahn in 2001 totaled $655 million, $217 million of that related to the Hollywood & Highlands retail/entertainment development in Los Angeles. TrizecHahn write-downs accounted for about one-third of the total for all of publicly traded real estate for the year, according to Jim Sullivan, an analyst with Green Street Advisors Inc. As a result, investors fled the stock, driving it down to $16.33, in Big Board trading Wednesday, from more than $27 a share in 1998, even as other office companies thrived during a booming real-estate market. Fears of management's next move led investors to discount the stock as much as 30% below the net value of the firm's assets. It still trades at about an 8% discount, compared with its office peers, which trade at a 5% premium, says Green Street. In December 2000, Mr. Munk stepped aside as CEO. And the 47-year-old Christopher Mackenzie took over. He has drawn praise for his plain-spoken manner and for steering Trizec toward the more mundane task of operating office buildings. So far, the reception for the new Trizec has been cool. Conspicuously absent from the list of shareholders are the largest funds dedicated to REITs. NOTE: In doing the REIT valuation charts, Trizec stood out as an under-performer. This info is posted here to explain Trizec's numbers - and because it is an investment oppertunity. More on TrizecHahn Rachel Cohen, Reuters 5-2 TrizecHahn in March said it did not expect to see a recovery in rental rates or demand until the second half of next year. It expects funds from operations of $2.37 a share this year and between $2.40 and $2.50 in 2003. Its dividend will quadruple to between $1.30 and $1.45 a share in 2003 from 35 cents in 2003 because of its transformation to a U.S.-based REIT. Outside of the United States, TrizecHahn is in the process of selling its properties in Canada and Europe. The ownership of non-U.S. properties will pass to a new company Trizec Canada. Trizec Canada will sell all the remaining properties outside of the United States and also have a 40% stake in Trizec Properties, allowing overseas investors to invest in the REIT. And More on TrizecHahn Garry Marr, (Canadian) National Post 5-1 The restructuring should improve valuation, said Lee Schalop, a New York-based analyst with Banc of America Securities. Ultimately, Trizec Canada will control the REIT's new board of directors, something that does not sit well with U.S.-based analysts such as Mr. Schalop. Louis Forbes, a Toronto-based analyst with Merrill Lynch, said it's still unclear whether Trizec Canada will be booted out of Canadian indexes because it is now set up as mutual fund corporation. Even if it remains, its weighting will be reduced in the TSE 300 index. "That will represent sell pressure, to what extent I don't know. The change in weighting is for sure coming down," said Mr. Forbes, who has been told by the company it is still eligible for the index despite being a mutual fund. In the interim, Mr. Forbes is staying "neutral" on the stock. "We're just saying people should stay away for now," he said. Valuations on Major Mall REITs (listed in order of Market Cap)
Valuations on Major Office REITs (listed in order of Market Cap)
Adjusted average omits Prentis' Pr/Sales ratio and Trizec-Hahn's P/E.
Atlanta Office Update Atlanta Journal-Constitution 5-2 Despite the addition of 14,000 new jobs in metro Atlanta so far this year, the local office market will continue to see high vacancy rates and falling rents until the excess space is filled. So says a report from Marcus & Millichap's Atlanta office. Average rent rose almost 10% last year to slightly over $20 per square foot, despite rapidly rising vacancy. This increase in rent is indicative of a higher proportion of Class A space rather than demand-driven rates. In 2001 the average sales price remained steady at $95 per square foot; however, this was supported by three Class A buildings that sold last year and accounted for more than 40% of total sales volume. Shorten Leases Keeping Industrial Sector Afloat Ray Smith, WSJ 5-1 As in the office and apartment real-estate sectors, tenants of industrial space are calling more of the shots these days. And industrial landlords have gone even further than office and apartment owners to attract and retain tenants, not only lowering rents but also agreeing to shorten leases. In fact, short-term leases are largely responsible for keeping the industrial real-estate sector afloat as declining manufacturing activity has left empty warehouses littered across the nation. In the first quarter of this year, the vacancy rate for warehouse space in the U.S. rose to 9.9%, the highest level since 1996, according to Cushman & Wakefield. That was up from 7.5% in last year's first quarter and approached the 11.2% rate in the fourth quarter of 1996. The average rent nationally for warehouses fell to $5.75 a square foot in the latest quarter, from $6.16 in the year-ago first quarter, Cushman & Wakefield says. Meanwhile, the average lease term for industrial space nationwide fell to 51.5 months in the first quarter of this year, from 69.5 months in the year-earlier quarter, according to Grubb & Ellis. "Tenants have negotiating power now," says Ross Smotrich, an analyst at Bear Stearns, speaking about real estate in general but emphasizing warehouse tenants. So much so, that they are beginning to act in anticipation of the next turn in the market. "You're starting to hear lease terms lengthening out a little bit," Mr. Smotrich says. That's in part because some tenants, believing that rent increases for warehouse space are just around the corner, are looking to lock in discounted rates. "In general we are starting to see, in selective cases, tenants requesting longer terms, which is a sign to us that they feel that the market is pretty much near the bottom in terms of rates," says Bruce Freedman, executive vice president and head of real-estate operations at San Francisco-based AMB Property. "Until recently, we had been seeing none of that." Several analysts see such deals as a signal that industrial real estate is the first sector of the market to be bottoming out. "It suggests there is more confidence in tenants' business outlooks, and that's a positive," says Jim Sullivan, an analyst at Green Street Advisors. "But I wouldn't overstate the importance of this. I wouldn't say it's widespread or that it's applicable to all markets across the country." Three REITs Pay Dividends Monthly Ray Smith, WSJ 5-1 Great Lakes REIT, a small-cap real-estate investment trust that owns office buildings in the Midwest, announced Wednesday that the company is converting to paying the dividend on its common shares every month rather than quarterly. Great Lakes REIT would be the third REIT to distribute dividends on a monthly basis, according to the National Association of Real Estate Investment Trusts. REIT Realty Income Corp. of Escondido, Calif. and U.S. Restaurant Properties Inc., of Dallas, also offer monthly dividends. "A large number of our current holders are individual investors who rely upon our dividend payments as a source of income to offset monthly living expenses," Chairman and Chief Executive Dick May said. "By paying dividends monthly rather than quarterly, we allow these shareholders to more easily match income to expenses and simplify financial planning." EOP Robert Burgess, Bloomberg News via Seattle Times 4-30 EOP is the only one of 21 members of the Bloomberg Office REIT Index to cost investors money in 2002 after dividends are included. EOP has shrunk 4.5%, while the overall index has returned 3.4%. EOP strayed from its bottom-fishing investment style last year when it bought Spieker Properties for $7.2 billion. Spieker had about 6 million square feet of office space in the Seattle area, much of it in the suburbs. The purchase came about a year after EOP paid $4.6 billion for another REIT with a West Coast focus, Cornerstone Properties, came when vacancy rates were at all-time lows of less than 3% in such places as San Francisco, San Jose and the Seattle area. Since the purchase, vacancy rates in San Francisco, Boston, San Jose and the Seattle area, which account for 45 percent of Equity Office's net operating income, have risen to more than 14%, and rents are down more than 20 percent, according to Torto Wheaton Research. EOP owns 768 buildings across the U.S. - more than 125 million square feet of office space, more than twice as much as its nearest competitor, Toronto-based TrizecHahn, whose stockholders this month approved its conversion to a U.S.-based REIT. In the Seattle area, EOP owns 64 office buildings totaling 10.4 million square feet.
More on EOP EOP has a total capitalization of approximately $27 billion at 12/31/01, and owns and manages 128 million square feet. The portfolio is balanced between central business district (44%) and suburban (56%) locations. (EOP annual report Feb 2002) EOP occupancy levels at all its properties fell to 90.7% at the end of Q1, down from 91.8% at year-end 2001, primarily because of early lease terminations. (Diana Rosenberg, Dow Jones Newswires 5-1) Quick Facts, Stats & Opinions In the last real estate cycle, the shift in values of office buildings from their peak to their trough was 56.6%. Retail real estate proved significantly less volatile, shifting 26.4% between peaks and troughs, while apartment buildings, the least volatile commercial property sector, changed only 18% in value. (Quoting a Moody's report, Financial Post 5-23) Until now, terrorism concerns focused on possible attacks occurring in public places like offices, banks, shopping malls or arenas. Late last week, the Federal Bureau of Investigation added apartment buildings to the list, notifying law-enforcement agencies and apartment owners and managers across the nation that al Qaeda operatives are considering renting apartments in unspecified areas of the U.S. and then planting explosives in them. (WSJ 5-22) According to AMG Data, funds flows into dedicated real estate funds have been "positive" every week since the beginning of 2002. Year-to-date (through March 8) net inflows into dedicated real estate funds total $807.3 million. And that total doesn't include the $510 million raised for Cohen & Steers Quality Income Realty Fund (RQI) and the approximately $160 million raised for the Salomon Smith Barney REIT UIT. (Realty Stock Review 3-8 [late posting because source is newly discovered])
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