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Under the maximum scenario of 220 million shares, a recently formed company affiliate called Hines Real Estate Securities Inc. could land fees of more than $170 million as the offering's dealer-manager. In addition, the deal is structured for a Hines affiliate to manage all of the assets acquired in the REIT, generating even more fees. Hines REIT primarily will invest in high-quality office properties throughout the United States. Mortgage loans, ground leases and related assets might also be targeted, according to the SEC filing. Depending on the deal size, Hines REIT could generate combined fees and costs of 9.5% to 11%, including commissions, dealer fees and associated costs, according to the SEC filing. That means roughly 90% of every investment would go into buying real estate, with the remainder going to fees and expenses. Private REIT Wells Sanctioned Dow Jones/AP 10-24 The National Association of Securities Dealers has sanctioned Wells Investment Securities, a sponsor of real estate investment trusts, for rewarding representatives of broker-dealers who sell shares of their REITs with lavish entertainment and trips.
Most survey respondents also said they expect less money to flow into real estate and predicted foreclosures, delinquencies and defaults will increase in 2004, but remain manageable. Of all property sectors, most respondents favored grocery-anchored retail centers, warehouses and apartments. The office sector was out of favor with most respondents. The survey was conducted by the Urban Land Institute and PricewaterhouseCoopers. From ULI's Press Release Retail returns will moderate, warehouses, apartments and hotels show slight improvements. Capital flows remain plentiful, but will diminish as an improving stock market draws attention away (from real estate.) In its markets to watch category, only Washington, D.C. received unwavering endorsement from respondents as a still-promising investment market, followed by New York and the Southern California region from San Diego to Los Angeles. "After that Ëugh,Ì" says the report. Other cities cited - either because their real estate markets are improving or because they are bargain bins - include Chicago, San Francisco, Seattle, Philadelphia, Phoenix, Houston, Denver, Atlanta and Dallas. Regarding development opportunities, the report notes that most 'mainstream' development should be placed on hold or severely scaled back, due to oversupply in nearly all sectors 'For 2004, developers have two choice - go to the beach or play golf,' comments an interviewer. The few exceptions: 1) for-sale housing in infill locations, which scored high interest due to downtown migration by singles and empty nesters, as well as tighter growth controls in outlying areas; 2) low- and moderate-income apartments in close-in areas to help fill the need for affordable housing; 3) brownfield restoration, which offers good prospects for town center housing; and 4) master-planned communities with open space and pedestrian-friendly design. In the Retail Sector: fueled by consumer spending, itÌs the only property sector with steady rents and occupancy rates. Major consolidation will occur over the next few years. Best bet: Fortress (income powerhouses) malls, prime neighborhood centers and best-located power centers. Outlook: Solid returns will continue. In the Industrial Sector: More efficient tracking systems cuts storage requirements and demand for space. Inadequate parking and access hurt many industrial parks. Best bet: Large regional distribution centers near airports, rail lines and ports. Outlook: As inventories get tapped out (over next few years), manufacturing and distribution will rise, benefiting warehouses. In the Apartment Sector: construction remains steady, adding to oversupply. Best bet: Hold onto core investments in supply-constrained marketsÙthose with high barriers to entry and a low supply of affordable homes. Outlook: Demographics will push up demand eventually. In the Office Sector: Suburban office markets should 'prepare for a free fall.' Best bet: Hold or buy properties with lease rosters with minimal rollover risk in the next five to seven years. Outlook: For 2004, revenues erode, values decline. Concession packages will keep real rents from stabilizing until 2005, and any income growth may be delayed until 2006 or 2007.
At the same time, Moody's believes the office market is beginning to absorb available space, and should show some rental rate growth towards the end of 2004. This is based on Moody's expectation of stonger growth in jobs starting in late 2003. The rating agency does not anticipate any substantial improvement in office employment within the next year, and does not see strong improvement in office property market conditions until 2005. Still, signs of hope are emerging. Moody's notes an increase in leasing activity and "shows" of space, and an appearance that tenants' decision paralysis is ending. Furthermore, some tenants are removing sublet space from the market. In addition, tenants that had excess space, choosing simply to absorb the costs by not subletting, are beginning to utilize more of this space, laying a foundation for stronger demand. In Moody's opinion, office market recovery is predicated on emergence and stabilization of job growth, as the number one driver of office tenant demand. All of the catalysts supporting job growth seem to be present: corporate earnings growth, and (in 2Q03) the first increase posted since 1Q02 in productivity and corporate investment.
In neighborhood and community strip malls, vacancies ticked up, to 7% in the third quarter from 6.8% in the second quarter. But retailers snapped up 65%, or 3.3 million square feet, more space than they did in the previous three months. Rents inched up 0.7%. Strip-mall vacancies are rising because new supply is coming on faster than new demand. And that is constraining rent increases. Reis projects that trend will continue for the next year and a half, with strip-mall vacancies eventually topping out at about 8% and rents rising just 2% to 3% annually. Strong consumer spending is primarily responsible for buoying the retail sector amid the recession, but sales per square foot of space have still fallen. Retailers opened new stores at a near-record clip in order to maintain market share. That may be the bridge that allowed retail investors to make it through the rough patch for the overall real-estate market. "The question lurking around the surprisingly positive performance of the retail sector has been 'Could this performance be sustained in the face of persistent job losses and mounting consumer debt?' " says Lloyd Lynford, chief executive of Reis. "If the September jobs gains don't turn out to be a one-month wonder, retail investors could succeed in escaping the travails of their brethren in the office and [apartment] sectors." Adds Jim Garvey, managing director of LaSalle Investment Management, part of real-estate services provider Jones Lang LaSalle: "The big question mark out there right now is what's going to result from the pressures...in the grocery-store industry." Wal-Mart's entry into groceries is causing concern among retailers who depend on grocery stores to draw customers to their strip malls.
But "with technology seemingly back in vogue," he believes there are "looming limits" to further real estate stock price gains. Conversely, if the economy weakens, he believes REIT dividends - especially among certain office and apartment REITs - could be in jeopardy. Callaghan is predicting only modest 3% to 5% funds from operations growth over the next five years, which is down from consensus projections of 6% to 7%. As a result, the analyst is recommending investors take profits. He remains bullish on certain select REITs whose valuations remain "reasonable." He upgraded United Dominion (UDR) to outperform from underperform, and raised Liberty Property (LRY) and Regency Centers (REG) to outperform from in line. He also rates Developers Diversified Realty (DDR), Rouse (RSE), Vornado (VNO), Simon (SPG), and Forest City Enterprises (FCEA) at outperform.
Under the new rule, REITs that hold a controlling stake in a joint venture must mark up the value of the minority partner's interest to current market rates, and this value is then recorded as a liability on the REIT's balance sheet. In other words, the value of the properties in the partner's share of the joint venture will be marked up to current market rates and expensed against the REIT's earnings. However, the REIT's share in the JV will not be marked to market, creating a disconnect between the assets and liabilities on the REIT's balance sheet. As a result, REITs will be taking special noncash charges in connection with the minority partner's interest in the JV, and experts say this could unfairly skew a REIT's earnings. "We're going to see a disproportionately high number of headline misses as a result of the implementation of FAS 150," said Deutsche Bank analyst Louis Taylor. "This is one of the most ill-conceived, poorly thought-out accounting pronouncements ever done," said Taylor. "This is just stupid." "The most troubling part of this accounting treatment is that the accounting only applies to the liability side of the balance sheet," Banc of America Securities analyst Lee Schalop said in a note. "We expect the implementation of FAS 150 will cause confusion this reporting season." Deutsche Bank's Taylor speculates that the National Association of Real Estate Investment Trusts, the trade group that represents REITs and real estate companies, likely will recommend the change not be included in FFO. However, he said such an exclusion likely won't occur before the first quarter of 2004.
Average rents declined 0.9% quarter-on-quarter to $20.85 from $21.03 per square foot. Rent prices were down 5.8% from a year ago. Absorption was negative for the 10th time in the past 11 quarters, down 5.3 million square feet. Building completions were down significantly in Q3, with just 4.1 million square feet of new space coming online. That is 40% less than in the second quarter and 68% less than in the third quarter of 2002. Sublease space continued to drop in the quarter to 19% from a peak in the high 20% range, according to Cushman & Wakefield. Markets Around the Country In the Dallas market, already staggering from the telecommunications bust, tenants put 800,000 more square feet on the market than they took in Q3, raising the vacancy rate to 26% from 25.5%. Denver, also hurt by telecom woes, posted a 2.4% decrease in rents in the quarter, and its vacancy rate rose nearly a full point to 21.7% from 20.8%. Kansas City and Raleigh-Durham performed best in Q2, each absorbing about 400,000 square feet of office space. Kansas City's vacancy rate fell to 17.6% from 18.5% and Raleigh-Durham's vacancies fell to 20.2% from 21.5%.
Mall REITs were a big winner, gaining 12.7% in Q3. Apartment REITs, even with oversupply and a lack of demand, gained over 11%. Industrial REITs gained 10.6%. The office sector posted total returns of 5.1%. Some analysts worry that current stock prices are disconnected from the reality of generally soft real estate fundamentals. REIT stock prices seem to reflect an unrealistic optimism about the speed and timing of an economic resurgence, something that could cause REIT prices to moderate in the coming months. "What is interesting to note is that real estate fundamentals remain soft in most product types across the country, although it does appear as though operating conditions are no longer deteriorating," noted Steve Sakwa, director of REIT research at Merrill Lynch. "The real question is whether fundamentals will improve fast enough to justify the recent stock price gains." "After experiencing a strong first half of 2003, office stocks fell out of favor during the third quarter as investors began to recognize that an office recovery was perhaps further away than originally expected," Sakwa noted. "Based on the most recent data from Economy.com, office employment figures continue to be revised downward in most markets across the country. As a result, we believe that net absorption of office space may be below our prior expectations, which would put downward pressure on earnings growth for most office REITs we follow." While northeastern office markets are somewhat stronger [than western and southern markets], rent rates remain depressed from cycle peaks, and companies with lease rollovers in the coming 12 months are likely to pay considerably less than they're paying today. Rollovers will likely pressure rents for quarters to come. Even though new office space is now slow to come to market, the demand bubble that burst at the beginning of this decade is likely to affect office REITs for years to come. "More importantly than the supply side of the equation is the total lack of demand for office space throughout the country," Sakwa concluded. "Even if economic growth is able to sustain itself at a 3% to 3.5% pace, we believe it will take close to five years before the nation's availability rate to fall back down toward a healthy equilibrium rate of 10%." If Sakwa is correct, reality may be difficult for office REITs in the coming quarters.
The vacancy rate for the CBD has risen to 20% at the end of the Q3, up from 19.8% a year ago. Suburban overall vacancy dropped to 20.6% at the end of Q3 from 23% a year ago, according to Cushman & Wakefield. The suburban submarkets of North Phoenix and Scottsdale are doing particularly well with vacancy rates of 15% and 13.3%, respectively. Currently, about 712,320 square feet of office space is under construction and Scottsdale is seeing most of the activity. Despite the signs of recovery, it looks like Phoenix may not see a more robust real estate market for another 24 months, said James Wentworth, senior managing director of Cushman & Wakefield. And given the amount of new development that is slated for the area, overbuilding is becoming a concern.
The average monthly rent dropped slightly, to $2.06 per square foot from $2.13 a year earlier. In the Burbank Media District, perhaps the tightest market in the county, vacant space fell to 4.7% of total space from 20.5% a year ago, while rent rose to $2.76 from $2.49. The vacancy rate in downtown Los Angeles was up slightly to 19.6%, from 18.7% a year ago, but average monthly rents rose to $2.06 from $1.99. Orange County, meanwhile, had a 17.2% vacancy rate and average rent of $1.93 in the third quarter, compared with 17.8% and $2.03 a year ago.
PM Realty's survey reflected the opinions of 62 commercial real estate brokers from several Houston firms. Some significant job growth is needed to start filling the office buildings. Over the last year, Houston has lost more than 8,000 jobs. The Houston office market ended Q3-03 with a 15.1% vacancy rate and an average rental rate of $18.07 per square foot, according to Trione & Gordon. A year ago in the third quarter, the citywide vacancy rate stood at 13.5%, and the average rental rate was $18.45 per square foot. Downtown's Class A office market had a Q3-03 vacancy rate of 17.1%, compared with 10% in the Q3-02.
Buyers of buildings in the Washington area, CB Richard Ellis found, are disproportionately real estate investment trusts (accounting for 28% of the purchases by dollar amount, but only 10% of the selling), and foreign investors (15% of the buying, but only 2% of the selling). But paying such high prices, with resulting low yields, could create risks for buyers. In recent months, interest rates and the stock market have both risen. If those trends continue, real estate could fall out of favor. Meanwhile, millions of square feet of office buildings are under construction in the District and inner suburbs, space that might create downward pressure on rents. Atlanta Office Sales The volume of big-building sales in Atlanta remains far below the peak years of the late 1990s. According to CB Richard Ellis, there have been $530 million worth of 25,000-square-foot-plus office building deals so far this year, compared to $585 million in all of 2002. Both figures are dramatically down from an average for the past decade or so of $1.2 billion to $1.4 billion and a high of $2.2 billion in 1998. (Charles Davidson, Atlanta Business Chronicle 10-06)
Those two nuggets of conventional wisdom, however, are more fiction than fact, according to a new report to be released Wednesday by Grubb & Ellis, a real-estate brokerage, and PNC Real Estate Finance. Tenants leasing space from landlords in top-quality [Class A] buildings accounted for about 60% of all leasing activity in the past several quarters, suggesting that demand for this type of space has remained constant, says Robert Bach, Grubb's national director of market analysis.
Apartment owners and analysts are viewing the slight uptick with caution, mainly because economic and employment conditions are still uncertain and because single-family home sales remain strong. What's more, the second and third quarters are traditionally stronger leasing periods in many parts of the country. Both quarters saw positive absorption, or new rentals, while the first quarter saw negative absorption, since new units built and added to the market exceeded new rentals. Reis expects new units to exceed new rentals in the fourth quarter, pushing the vacancy rate up to 6.9%, which would be the highest it has been in more than a decade. Richard J. Campo, chief executive of Camden Property Trust, a Houston-based apartment REIT that owns 51,344 apartment homes in the Sunbelt and Midwestern markets, from Florida to California, said the company saw a rise in demand for apartments "as measured by people coming in the door" inquiring about apartments. He said concessions helped the portfolio reach its highest occupancy level - about 94.5% - in two years. Still, the company, like other owners, isn't ready to pull back on concessions yet.
According to RealFacts, a research firm that tracks apartment data, the most significant gains in occupancy occurred in Boise, Idaho, and Austin, each jumping 3% from the beginning of July through the end of September. Oklahoma City and San Diego followed, with improvements of 2.7% and 2.6%, respectively. Similarly, RealFacts found that the number of cities with occupancy decreases continued to fall. At the end of the first quarter of 2003, 13 markets had drops, compared to nine in the following three months and just three in the most recent quarter. Other good news occurred with rents. Sixteen markets experienced rental rate increases. And in nine of those markets landlords hiked rents at least 1%. Some places were still suffering. San Jose's apartment rents were off nearly 9% from the same period a year ago, and both Austin and Dallas had rents that were down by at least 5% from the third quarter of 2002. Quick Facts, Stats & Opinions Equity REITs yielded over 9% in late 1999. But after four years of spectacular share-price gains, equity REIT payouts are below 6%, calculates Washington's National Association of Real Estate Investment Trusts. The last time yields were below 6% was in early 1998 - and performance was dreadful for the next two years. (Jonathan Clements, WSJ 10-08) The single biggest positive for REITs now is that the economy is starting to show signs of life. My picks are perking up again as occupancy rates and rents stabilize and new additions spur earnings and funds from operations. Even California-troubled BRE Properties' (BRE) dividend [5.9%] looks relatively safe: Debt ratios have stabilized and faster dividend growth seems likely. The only real negative for our REITs is valuations. Yields are at their lowest levels in years. The average price-to-FFO of our picks is now 13, relative to a projected growth rate of less than 7%. Most ominously, three trade at more than 40% above their book values: Chelsea Property Group (CPG), BRE and Washington REIT (WRE). Those are all-time highs. (Roger S. Conrad, Personal Finance via Washington Post 10-5)
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