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That has widened the growing gap between the cost of living in the Northeast or parts of California and the cost of living almost anywhere else. Three years ago, for example, a typical 800-square-foot one-bedroom apartment in Los Angeles cost the same as a 1,480-square-foot two-bedroom in Charlotte, N.C.; today, the Los Angeles apartment costs almost as much as 1,900 square feet in Charlotte, according to Economy.com. The portion of apartments sitting vacant this summer rose to 9.9%, the highest level since the Census Bureau began keeping statistics in 1956. Between late 2001 and this summer, the average rent per square foot fell 4.8% across the country, according to the National Real Estate Index, which is published by Global Real Analytics, a research company. The declines are also a worrisome sign that the nation's housing market has begun to suffer from some of the same problems of oversupply that have already hurt manufacturers, economists say. If mortgage rates continue increasing, as is widely expected, people who might have bought houses will instead rent. That could shift the burden of the excess supply from landlords onto homeowners, hastening the end of a decade of rapidly rising house prices. Rents in some cities could stop their decline soon, especially if the economy continues to gain strength, apartment owners and economists say. But few analysts say they expect rents to start rising anytime soon. "We don't see recovery until 2005," said Gleb Nechayev, an economist at Torto Wheaton. "There is just too much construction. There are too many units coming onto the market."
Cushman & Wakefield Inc. recorded 500,000 square feet of positive absorption in the city. Other firms did not put the figure quite as high, but the consensus is that things are definitely moving forward. The Valley, meanwhile, has not had a quarter of positive absorption since late 2000. The market peaked with a 25% vacancy rate after the second quarter. That fell to 23.2% in the Q3. There is still a huge glut of empty space. But any good news at this point is reason to celebrate. Beyond the real estate figures are some macro-economic trends on the rise. The rate of job loss has slowed. The jobless rate has fallen less than 2% in 2003. That may not sound wonderful, but that is an improvement over 2002 and 2001, when jobs were disappearing at a clip of more than 5% each year. It will be a while - possibly years - before rental rates start moving upward. Rates have stabilized in both the city and its suburbs. But to start moving upward again, vacancies need to return to single digits. That won't happen soon, even with the market entering a recovery.
Rapidly mounting vacancies (an average 12% nationwide in 2003, versus 4.7% in 2000) and declining effective rents for Class A office space - meaning the best space in downtown/central business districts ($35.38 a square foot now, compared with $41.30 in 2000, according to New York-based Reis) suggest that tenant demand for high-priced commercial office space has weakened dramatically. Meanwhile, landlords' expenses, especially insurance and taxes, are rising. These trends don't bode well for property owners or investors. Yet despite deteriorating fundamentals, the sale price per square foot for Class A office space has remained steady, or has even risen in some markets, and some individual commercial buildings have fetched record prices. The capitalization rate (net operating income to market value, expressed as a percent) has declined from about 9% in 2000 to around 8.5% now, according to the RERC Real Estate Report. And just as high price/earnings ratios for, say, tech stocks during slowdowns in corporate spending on computers and software indicate that these shares are overvalued, low capitalization rates in the face of receding demand point to a discrepancy between real-estate prices and values. Similarly, the spread between dividends paid by real-estate investment trusts and interest rates has also increased, making REITs look more attractive to individual investors. While REIT dividends lately have been falling a bit, prices of REIT shares have moved sharply above the value of the assets underlying them. Indeed, in the 12 months through June, share prices moved from a 20% discount to net asset value to a 10% premium. This widening difference provides further evidence of a growing real-estate bubble, driven in part by retail investors. If capital continues to be drawn to new properties while vacancies are increasing and rents declining, the disparity between price and value will continue to worsen. Not long ago, the Economist posited the idea of an "investment clock" that governs the sequential boom and bust cycles of four investment categories -- bonds, stocks, commodities/property and cash. Simply put, a boom or bust in equities is followed by the same in commodities/property, followed by cash, then bonds, until it begins anew with equities. And the clock is ticking for the bursting of the commercial-real-estate bubble.
To understand the realities facing local REITs, consider Federal Realty Investment Trust, also of Rockville. The firm specializes in building and managing retail space, especially strip shopping centers anchored by grocery stores. But it is not building new strip centers; after all, retailers have been in little mood to expand with the soft economy of the past three years. "We have really had a renewed focus on redeveloping existing properties," said chief executive Donald Wood, seeking to squeeze as much money as possible out of its existing portfolio rather than adding to it significantly. "You have a lot of capital chasing simple income-producing assets," said Mitchell Schear, president of Charles E. Smith Commercial Realty, a division of Vornado. But he and others say that prices have risen less for properties that need fixing up - those that, for example, are in dire need of renovation or have significant empty space inside to be leased. Archstone-Smith Trust [ASN] has about 40% of its assets in the Washington area. Its operating results from local properties are stable; revenue from existing facilities in the Washington area was up 1.1% in Q3 compared with 2002. But ASN lately is being very cautious in what it builds and buys; prices have largely been too high for major purchases, said Al Neely, an EVP of ASN. The firm is putting money into renovating the lobbies of existing buildings, trying to squeeze more money out of them.
For investors, these preliminary findings suggest that the S&P REITs may be losing two of their biggest selling points: diversification and stability. Adding fuel to the fire is the recent performance of some large REITs. Take Apartment Investment & Management, which became part of the S&P 500 in March. On the day the Denver-based apartment-building landlord significantly lowered its third-quarter earnings guidance, investors pounded the company, sending its shares down 17%. Aimco's plunge followed a big drop in shares of Prologis, the warehouse giant, which fell 8% to $29.08, following a disappointing earnings announcement on Oct. 22. A strenuous lobbying effort by REIT executives and the industry's trade group, convinced the Index Committee of McGraw-Hill Cos.' Standard & Poor's unit to include REITs in the S&P 500. For the REIT industry, it may be a case of "be careful what you wish for," says Robert Stevenson, a Morgan Stanley REIT analyst. Trading volume in the six REITs - which also EOP, EQR, Simon, Plum Creek Timber - has jumped an average of 51% since they were included in the index, the Morgan Stanley study found. And they've behaved more like the rest of the S&P 500. Before being added to the index, for instance, shares of Simon Property correlated to the S&P by a very low factor of 0.19, Morgan found. That means that for every 1% move by the broader market, Simon would probably move only 0.19% in the same direction. But after Simon's inclusion in the S&P in June 2002, the REITs' shares' moves have correlated to the index by a factor of 0.52, an increased correlation of 167%. The study found dramatically increased correlation for all the big names. "It's good news, bad news," says Mike Kirby, a principal with Green Street Advisors. "REITs have done a great job of selling themselves as a diversified investment. But now, they may not be as good at that."
Philip Kibel, Moody's vice-president/senior credit officer and the report's author, said that most US industrial REITs entered the 2001 recession well prepared financially and strategically, with modest levels of secured debt, well-laddered debt maturities, healthy fixed charge coverage and good business models. "These REITs have also contained their development risk," he said. "Over the near- to medium-term, Moody's believes that it will be difficult for the industrial property sector to sustain absorption of space if even a small amount of new supply comes on line." A slow economic recovery with little to no capital investment by corporations would also slow the industrial property sector's rebound, the rating agency says, which could be further complicated by the usual lag in real estate sector's recovery behind that of the economy at large. Industrial REITs are one of Moody's most highly rated REIT sectors. Mr Kibel said the five major industrial REITs Moody's rates carried investment-grade ratings and stable outlooks.
Because of their aggressive buying, these companies are helping to drive up prices, some real estate specialists say. The four companies have something significant in common. All refer to themselves as nontraded public real estate investment trusts, but many real estate specialists describe them as "private REIT's". This year, these REIT's are expected to raise $7 billion to $8 billion. Wells alone has raised $3.8 billion since 1998. In comparison - the 171 public REIT's tracked by the National Association of Real Estate Investment Funds, a trade group, have raised about $18.5 billion this year.
More than two-thirds of the thirty smaller markets Ries follows posted positive absorption combined with falling vacancy, and 19 saw their rents increase. markets saw their average vacancy rates fall by thirty basis points during the quarter and rents tick upward by the same amount. Unwavering developer and lender optimism for the Apartment sector has undermined the process of recovery, as new apartment properties have been added - and continue to be added - as if it were still 1999. Over the next two years, Reis is tracking projects scheduled for completion that will add an average of more than 25,000 units per quarter to the top 50 metropolitan markets. As we look ahead, this quarterĖs slight dip in vacancy begins to reveal itself as promising but probably anomalous until 2005. Reis sees vacancy topping out at 7.0% in 2004, and added pressure next year to sweeten concessions packages in order to push that vacancy down. Not until 2005 do we see circumstances finally shifting, appreciably and sustainably, in favor of landlords.
Now comes news from a Bank of Tokyo-Mitsubishi survey, as reported by Shopping Centers Today, that same-store sales rose for every major retail category in September, which recorded the best monthly gain since March of 2002. The average increase for all 77 surveyed chain stores was 5.9%. It is notable that discounters logged a 5.8% same-store increase compared to a relatively anemic 2.8% for department stores. Only in Cincinnati, Pittsburgh, and Palm Beach did retail landlords feel compelled to ask for less rent from new tenants. In 45 of the top 48 markets, landlords were bold enough to ask for more, and in 39 markets they managed to win increases averaging 1.2%, with Oakland (2.5%), San Diego (1.9%), and Sacramento (1.8%) leading the way. Some of the same markets hardest hit by declining office market performance are the very same markets recording extremely low retail vacancy rates. Six of these markets are in California: Orange County (4.3%), Oakland (4.2%), Los Angeles (3.9%), San Francisco (3.8%), San Jose (3.4%), and San Diego (2.6%). These markets recorded an average effective rent increase of 1.4% on the quarter, double the average national increase of 0.7%. Among the 29 smaller retail metro markets that Reis tracks, we see roughly the same ratio of negative to positive results, with fourteen markets recording negative absorption, fifteen recording rising vacancy, and rents falling in six metro markets. Looking ahead, Reis sees the retail market adding new space at a rate of roughly five million square feet per quarter through 2006. This relatively sober pace of new construction will allow landlords to continue to achieve higher effective rents even as the national average vacancy rate drifts upward roughly 100 basis points between now and mid-2005 before beginning drop again toward the low seven percent range. Retail trends will continue to favor discounters and tenants of neighborhood and community centers more than department stores and larger malls.
Despite this overall glum news, during Q3 there were a few bright spots. In 13 of the 31 metropolitan markets to which new space was added in the quarter, leasing activity was robust enough to result in net positive absorption. Standouts include the District of Columbia, Atlanta, Baltimore, Los Angeles, and Miami. These five markets, comprising 15.5% of the total national inventory, posted an average vacancy rate of 14.9%. During Q3, the effective rents in theses five markets were down 76 basis points from the previous quarter, compared to 110 basis points for the national average. In only eight markets did landlords manage to eek out small increases in effective rent: San Bernardino, Orange County, Indianapolis, Tampa, Richmond, San Antonio, Nashville, and Milwaukee. In only two markets, Orange County and San Bernardino, accounting for 2.8% of the U.S. inventory, did effective rents and occupancy rates jointly increase. In other words, during Q3 the owners of the other 97% of the office properties in the U.S. took a hit with respect to either rents, occupancies, or both. Reis anticipates a stabilizing of the office market next year. The U.S. vacancy rate will rise another 30 basis points next quarter, ending this year at 17.1%, before finally beginning a slow and steady ebb to finish 2004 at 16.8%. Quick Facts, Stats & Opinions There are sectors in the Houston market for which we can give thanks this year. The proliferation of new rooftops has created the need for a lot of suburban strip centers, grocery stores, branch banks and restaurants. The shopping center market is steady, despite the creation of a lot of new retail space. Houston-area shopping centers had a Q3 occupancy rate of 85.3%, down slightly from 85.5% a year earlier, according to O'Connor & Associates. Houstonians should be thankful they don't own an office building in Dallas, which has the emptiest office markets in the nation, and rental rates have plummeted. One-fourth of Dallas' office space sits vacant, according to the Marcus & Millichap real estate firm. Houston looks great in comparison with its citywide vacancy rate of 16.6%. (Ralph Bivins, Houston Chronicle 11-29) Speculative development has been rare in Los Angeles County since the early 1990s, when demand for office space collapsed with the economy. But Burbank's Media District is a popular office market hemmed in by movie studios, residential neighborhoods and the Ventura Freeway. Office vacancy in the Media District was 4.7% at the end of the third quarter, down from 20.5% a year ago, according to Cushman & Wakefield. Average rent rose to $2.76 per square foot per month from $2.49 in the same period last year. (Roger Vincent, LA Times 11-29) In Australia, a vast proportion of prime real estate is owned and operated by listed property trusts, or LPT's, the local equivalent of REIT's. In fact, more than 40%t of investment-grade properties in Australia are held by such publicly traded companies. That compares with 10% to 15% in the U.S. Analysts say Australia is home to one of the world's most developed listed real estate markets. The U.S. market is the largest - $150 billion in market capitalization, compared with $32 billion in Australia. But listed property trusts represent a relatively large 6% of the capitalization of the Australian stock exchange. (Miki Tanikawa, International Herald Tribune 11-18) Economics forecaster Susan Hudson-Wilson, speaking recently at the annual meeting of the Association of Foreign Investors in Real Estate, said that job growth in the office sector, as opposed to on the factory floor, "has already turned the corner." She even pinpointed six cities that will attract the greatest number of office jobs by 2010: Atlanta, Chicago, Dallas-Fort Worth, Los Angeles, Phoenix and Washington, D.C. (Neil Weilheimer, CPN 11-17) Most office tenants - more than 70% - don't plan to expand the size of their offices next year. And, despite all those enticing rent deals, more than 80% of tenants plan to renew their leases, a poll by PM Realty Group found in a survey of almost 60 local real estate brokers. Proximity to the workers' homes was a distant fourth on the list of hot buttons. (Steve Brown, Dallas Morning News 11-08) The number of Californians able to afford homes dropped 4 percentage points in September, to 25%, from the same period a year ago, according to the California Assn. of Realtors. San Diego was the least affordable county in Southern California, with only 17% of residents able to afford homes. The High Desert region, at 57%, was the most affordable. Orange County's affordability fell 6 percentage points, to 18%, from last year, and Los Angeles County's fell 6 percentage points, to 24%. Affordability in Riverside and San Bernardino counties dropped 11 percentage points, to 35%. Ventura County saw a decline of 8 percentage points, to 22%. (LA Times 11-09) Reis forecasts that 19.6 million square feet of new retail space is under development this year. That is not much of a decrease from the 20.9 million square feet during 2002. (Jennifer Duell, CPN 11-06) Trizec expects 2003 FFO per share in the range of $1.84 to $1.86. Trizec's 04 FFO guidance is in the range of $1.60 to $1.70 per share. The guidance reflects the company's view that office market conditions generally are stabilizing, but not improving until at least late 2004. Trizec expects its 2004 occupancy levels to remain relatively flat, with fewer termination fees and other one-time events affecting earnings than in 2003. Trizec said FFO will also be impacted by dilution from asset sales. (11-06-03) The National Association of Realtors Housing Affordability Index stood at 136.6 in Q3, down 7.2 percentage points from 143.8 in Q2 and the lowest reading since 135.3 in Q3-02. The index shows a typical household had 136.6 percent of the income needed to purchase a home at the third-quarter's median existing-home price of $177,000. The index assumes a 20 percent down payment and a third-quarter U.S. median family income of $53,641. The typical family could afford a home costing $241,800 in the third quarter. A family earning $20,000 could afford a $90,200 home and an $80,000 household could afford a property valued at $360,600, according to the NAR. (Rachel Koning, CBS.MarketWatch 11-03) Real-estate investment trusts have pulled in $3.5 billion in fresh investment dollars in 2003, a figure equivalent to 22.9% of their assets. (Jack Willoughby, Barrons 11-02) The BLS reported Wednesday that the Atlanta area gained 65,700 new jobs during the 12 months ending in September. The next highest gains were in Las Vegas, which added 23,700 jobs, and Phoenix, which added 19,400. Between August and September, Georgia added 13,300 jobs, second only to Florida's 20,800. The job gains in Atlanta were led by professional and business services - legal, accounting, janitorial and landscaping, among others - and by private-sector education and health care. (Dick Pettys, Associated Press via AJC 11-2) In North Texas, 31 telecommunications companies employed 90,799 people at the beginning of 2001, according to statistics compiled by The Dallas Morning News By early this year, the firms and their spin-offs had 69,177 employees. The industry employs 4.3% of all private-sector workers in the Dallas area, according to the Bureau of Labor Statistics. About 34.1% of office space in [the Telecom intensive office space of Dallas suburbs] Richardson and Plano is vacant, up from 29.3% in 2002 and 18.4% in 2001. Much of the fiber wiring installed during the 1990s remains unused. And data centers have vast stretches of empty floor space where servers, routers and other equipment were supposed to go. (Vikas Bajaj, Dallas Morning News 11-1)
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