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The strong capital flows and generally weak property market and operating fundamentals raise concerns about REIT valuations over the next 12 months. REIT share prices tumbled more than 22% in 1998, the last year following back-to-back years of healthy capital inflows. The sharp decline in 1998 came despite healthy and steadily improving property market and REIT operating fundamentals. REITs look expensive by almost any historical measure. Most REITs are trading at premiums to their underlying net asset values (NAV). According to Green Street Advisors, equity REITs were trading at an average 9.2% premium to NAV at the start of December and only 5% of all REITs were trading at a discount to NAV. REIT earnings, as measured by FFO, have fallen for two straight years, or by about 6% since year-end 2001. According to Prudential Equity Group, retail was the only major property sector with positive FFO growth in 2003 [Shopping centers up 7.78% and malls up 10.86%. Prudential must ignore the health care segment - which was up over 2% - and increased in 7 of the 11 companies I chart]. Earnings declined more than 6% in the industrial and office sectors [down 4.38% for office and 4.00% for industrial by my non-cap weighted figures] and more than 13% in the apartment sector [my figure is -12.37%]. Analysts expect earnings in most property types will rebound over the next 12 to 18 months. But even if REITs achieve the 4% FFO per share growth that analysts forecast for 2004, which likely will be revised down as companies report their 2003 results and give guidance for 2004, REIT earnings will still be slightly lower than in 2001. Rising share prices and falling earnings have led to higher REIT multiples. At year-end 2003, REITs were trading at a price-to-FFO multiple of more than 12x, well above the 11.2 average multiple since 1993. REIT multiples have not been this high since 1997, the height of the REIT bull market, when the average price/FFO multiple peaked at more than 14x.
Shopping-mall vacancies also declined, falling to 5.6% in the fourth quarter from 5.7% - the first decline since the first quarter of 2003. But rent growth slowed considerably; rising just 0.2% to $37.93, as landlords offered more-aggressive deals to lure retailers. Rents had grown by at least 1% in the two previous quarters. "We're seeing really aggressive deals made that you hadn't seen in the past," said Jarid Tollin, executive vice president of Newmark & Co. Real Estate's retail arm. "In order to entice the better tenants, they are getting better rents and more incentives in construction allowances and free rent in order to make the deals." Anemic sales in 2003 by apparel stores, which make up 47% of total shopping space in malls, led to the slowdown in mall rent growth, said Lloyd Lynford, chief executive of Reis. "What appears to be a strong holiday season inside and outside of malls is a positive sign for 2004," he says. "But mall operators will likely step carefully during lease negotiations until there is evidence of sustained improvement in mall-shop sales." Still, retail real estate is faring well, compared with the slump in the rest of the commercial real-estate economy. Strip-center vacancies are up 0.9 percentage point since the first quarter of 2001, but asking rents have increased 6.9%. Mall vacancies are up 0.6 percentage point over the same time frame, and rents are up 10.9%. That contrasts sharply with the national office market, where vacancies have nearly doubled since the first quarter of 2001, to 16.9% from 8.6%, and asking rents are down 14%. Apartment vacancies have more than doubled, to 6.9% from 3.2%, but rents are up 4.1%. Still, Reis forecasts strip-center vacancies will rise to 7.6% this year as new buildings exceed new demand. The company doesn't forecast mall vacancies.
"I think we will see some more weakness in the multifamily market in contrast to the single-family market," said Frank Nothaft, the top economist for mortgage giant Freddie Mac. "We've seen the absorption rate on newly built apartments decline significantly in the last two years. "Rent growth has been stagnant for the last two years," Mr. Nothaft said. "I don't see any further deterioration in market conditions, but I don't see any immediate turnaround." Apartment landlords had almost 175,000 tenants move out in 2001 and no increase in tenants in 2002, Dallas apartment analyst Ron Witten told builders at the meeting. "2003 net rentals were around 50,000, and it will be higher this year and in 2005," Mr. Witten said. "But we continue to build the same number of units today as we did back when there was tremendous demand." The imbalance is especially apparent in the Dallas-Fort Worth area, where tenants leased just 4,800 additional apartments in 2003. At the same time, developers were building almost 12,000 units. Dallas was one of the top apartment building markets in the country last year and will be again in 2004, Mr. Witten said. "Just as the market really hit the skids, we saw the starts accelerate nationally," Mr. Witten said. "We have more bad news ahead with an increasing number of apartments entering the market in 2004. "One of the reasons is interest rates are low," he said. Apartment developers are cashing in on the low financing costs that allow them to build rental units cheaper. And investors are still betting that profits on apartments - albeit less than originally promised - will beat other investments. "The capital markets haven't cut off money for apartments like they have in every other downturn I have seen," Mr. Witten said. Residents who've stayed in apartments have had a windfall. "Rental rates have been declining on an effective basis since the tail end of 2001," Mr. Witten said. Nationwide apartment rents were down about 1% last year and fell by more than 3.5% in North Texas, studies show. "The only way to survive as an owner of apartments is to cut prices," Mr. Witten said. More National Apartment Stats Ray Smith, WSJ 1-23 The average vacancy rate for the 50 biggest metropolitan markets in the U.S. rose to 6.9% in Q4, up from 6.6% in Q3 and 6.3% at the end of 2002. The 2003 rate is the highest since 1988, when it was 7.2%, according to Reis. Reis raised its 2004 vacancy forecast to 7.1% from a previous forecast of 7%. Absorption of apartments turned negative in Q4 after two straight quarters of positive absorption, hardly surprising given that October, November and December typically are slow leasing months. For the full year absorption was positive, totaling 30,864 units, marking the first time that indicator was positive on an annual basis since 2000. Meanwhile, effective rents rose to $859 a month, from $857 in Q3 and $857 at the end of 2002. Reis bases its rent figures on a blended average of studios and one-, two- and three-bedroom apartments.
Overall vacancy normally registers at higher levels in the Class "A" product sector than in Class "B" or "C" communities. That simply results from the introduction of new stock, as the Class "A" inventory includes projects that are just finishing construction and still are in the process of attracting an initial base of residents. Today, however, upper-tier properties (defined in general terms as projects built since 1990) actually have the lowest vacancy rates in a growing number of metros. The list of markets where this trend registers is a diverse group, as itĚs hard to find much common ground between Minneapolis and Greensboro or Las Vegas and Columbus. Perhaps most surprising are the lower vacancies registered by newer properties in Atlanta, Houston and Dallas - metros where new supply continues to pour into the market at a very aggressive pace, leaving a sizable block of product still in the initial leasing stages. While itĚs typical for areas with active construction to garner the lionĚs share of demand simply in reflection of product availability, itĚs not the norm for locales where the inventory is dominated by older stock to simultaneously suffer considerable net move-outs. However, thatĚs what is now taking place. Whereas change in rent achievement traditionally is the result of patterns exhibited in demand and vacancy, it is the change in rent structure that is actually driving the demand and vacancy trends in select neighborhoods. Thus, in a very unusual pattern, the biggest rent cuts in some metros are occurring in the areas that have the lowest or downward-trending vacancy rates. The Bolingbrook/Romeoville area of metro Chicago provides a vivid illustration. There, vacancy actually dropped 1.2 points during the past year, in contrast to the 1.4-point increase in vacancy registered across the metro as a whole. To achieve this decline in vacancy, owners and managers in Bolingbrook/Romeoville apartment communities slashed rents with a machete, attracting some demand that otherwise likely would have been captured elsewhere. Effective rents in the submarket were reduced 6.5%, compared to the metro norm of 3.6%. Similarly, rent cuts much more severe than the metro average led to unusually strong demand and easing vacancy in AtlantaĚs East Cobb County submarket and the West Inner Loop area of metro Houston. Looking ahead, then, expect Class "A" projects and neighborhoods where the apartment stock is heavy on newer product to lead the way toward occupancy recovery across most metros during the near term. However, even with this segment of communities capturing the most demand, vacancies likely wonĚt be reduced to a degree that will allow rents to regain momentum.
It's a far cry from last year's report, which projected going-out-of-business sales, leaving buildings dark and future anchors undecided. Developers and retailers spent last year plugging holes created by several years worth of departures from North Texas centers. The glut of vacated space has allowed new companies a quick entry into the market, existing retailers a chance to expand and centers the ability to redefine themselves. Last fall, Conn Electronics, of Beaumont, Texas, entered the Dallas market with three stores, one each in former Service Merchandise buildings in Dallas, Richardson and Lewisville. Were it not for the available space, Conn's might not be here yet, most certainly not with three stores, company officials said. In Addison Town Center, filling three vacancies enabled Regency Centers to buy the development last May. Bringing successful tenants such as Target, Kroger and Petsmart not only rejuvenated the center, but also kept the smaller tenants from pulling out, said Regency's regional director, James Buis. "Addison Town Center was always a good location, but it was just underserved by the wrong tenant mix," Mr. Buis said. "Spaces like this, tenants come in and generally do better than new space, where they are usually creating a market that has to grow to get the new sales." Dallas-area retail new construction fell from 3.5 million square feet to 3.4 million. But it's hardly reasonable to expect construction to reach the 8.3 million mark of 2000 or even the 5 million mark of 2001, Mr. Weitzman said. Mall leasing remains strong at 92%, but two regional malls will be taking a hit. Lord & Taylor is to leave NorthPark and the Shops at Willow Bend in Plano. Filling those voids in malls may not be as easy as getting retailers to take space at newer locations.
The trend is expected to continue as discount stores grow in popularity and expand in an improving economy. Wal-Mart plans to add 306 U.S. stores in fiscal 2004. Lowe's home-supply chain plans to add 140 stores this year, Target expects to add about 100 and warehouse club Costco plans about 30. Staples expects to open 90 new stores in the USA and Canada. Many large discount chains prefer to build from the ground up to fit their specific floor plans and models rather than retrofit empty stores. It's not that there is a lack of available space. The retail vacancy rate was 7% in the third quarter, about even with prior quarters, according to real estate research firm Reis.
But where REITs were outperforming the stock market all of last year, the relationship has changed in the past few weeks. The technicals are starting to flash some warning signals. Relative strength, or performance relative to the S&P 500, shows a steep change in which asset class - REITs or stocks - is getting the biggest play from investors. Other technical signals, such as momentum, show that each new higher price peak is accompanied by lower peaks in the indicators. Like a ball thrown up in the air slows down due to gravity before it actually starts to head back to earth, so do stocks. The direction may still be up, but the speed of those gains is shrinking [a declining momentum]. Shares of Simon Property Group have moved from roughly 32 to 50 in the past year. Its last two weeks it has reached fresh all-time highs, yet investor demand has tailed off a bit. this is indicated by on-balance volume, an indicator that measures volume trading on rally days minus volume on declining days. The more activity there is on days when prices are rising, the stronger the investor demand. When there is more activity on the down days, theoretically there is more urgency to sell, and that is not a good thing. Equity Residential Properties Trust not only shows deterioration in momentum and demand, but it already has made a preliminary break below its rising trend line. Most interestingly, these negative moves occurred during a period when interest rates were making a sharp move lower. We'll let the fundamental analysts ponder whether declining interest rates are good for real estate investing or bad for the ownership of tangible assets. Technical analysts will note that the charts of the homebuilders are not too dissimilar from those of the REITs over the past year, so weakness in both, despite falling rates, makes us think that the stocks/REITs are telling us something. Again, the trends in the sector are still up, but with so many warning signs popping up. It makes sense to take a hard look at possible price appreciation over the next few months versus the chance that the top is actually in. Insider Selling Among REITs Up 14-Fold J Morrissey, Dow Jones Newswires 1-20 In what could be one of the biggest indications yet that real estate investment trust stocks may have peaked, insider trading rose 14-fold in the fourth quarter. A Lehman Brothers report released Tuesday, found insider selling took place at 27 of the 35 companies that the firm tracks, up from six REITs a year ago. Insider selling totaled $286.4 million, up from $20.6 million a year earlier. About 81% of the sales involved options, compared with only 3% a year ago. Analysts speculate the jump in options activity may be related to options that were granted to executives during initial public offerings five to 10 years ago. The healthy rally among REITs in 2003 prompted many executives to exercise options before they expired.
Nowhere are landlords under more pressure than in the South Bay, the only market that showed a net loss of tenants for the year. The 2003 loss - 489,475 square feet - was even worse than that of 2002 - 369,148 square feet. Most of that loss was in El Segundo, the Los Angeles International Airport area and along 190th Street. The Westside also took a beating after the collapse of many Internet start-up companies and the recession that followed, but its vacancy rate fell in the fourth quarter to 17.3%, compared with almost 20% in the same period a year before. Average rent ticked down from $2.84 to $2.80 a square foot. In downtown L.A., the county's next-largest market after the Westside, vacancies dipped slightly to 18.9% in the fourth quarter from 19.6% a year before. Average rents rose to $2.25 from $2.13. Rents will go up more in 2004 as space is absorbed, predicted landlord and developer Robert Maguire, chairman of Maguire Properties. The so-called Tri-Cities market of Burbank, Glendale and Pasadena continued to show a lot of leasing activity. Overall vacancies dropped to 14.5% in the fourth quarter from 18.6%, and average rent fell 3 cents to $2.36. In the San Fernando Valley, vacancies fell to 13.7% from 16.5%, and rents rose 2 cents to $2.32. Central county office markets such as Hollywood, Mid-Wilshire and Alhambra saw vacancies dip 1 percentage point to 18.1%, and the average rent came down noticeably, to $1.73 from $2. The tightest individual market of substantial size was the Burbank Media District, where the vacancy rate hit 4.1% in the fourth quarter at rents of $2.82, a tremendous drop from 19.1% a year before, when rents averaged $2.76. The worst performer was the area around LAX, where vacancies rose to 30.2% in the fourth quarter from 25.4% a year before. Rents were $1.49, down from $1.53 a year before. Related: SoCal Office and Industrial Update - Jennifer Duell, CPN, Casden Real Estate Economics Forecast - USC Lusk Center
Retail Update As L.A.'s population continues to swell, so does the need for retail. Development and leasing activity is very strong, as is investment activity. There is a dichotomy between north Los Angeles County and south Los Angeles County. Because the southern part is a more mature market, most of the existing retail is obsolete and needs updating. To that end, most development opportunities are either infill or redevelopment. Redevelopment is not as prevalent in north Los Angeles, a newer area that tends to encourage ground-up development. The retail activity is a result of new home growth. According to CB Richard Ellis, south Los Angeles County's retail market had a vacancy rate of 5.3% at mid-year. The area posted absorption of almost 1 million square feet. Rents continue to increase both in the regional mall sector and grocery-anchored and community centers. As of mid-year, the average annual rent was $23.64 per square foot, up $2.04 per square foot from the same period last year, according to CB Richard Ellis. According to Real Capital Analytics, about $2.5 billion worth of retail assets traded hands since the end of the second quarter of 2002, including several large malls. Cap rates range between 7 and 9 percent for mall assets and between 6 and 8 percent for grocery-anchored centers. Most of the retail buyers were REITs.
The apartment vacancy rate in eastern Loudoun hit 9.5% at the end of 2003. That is the third-highest vacancy rate in Northern Virginia, after Vienna's 16.4% and Reston-Herndon's 12.7%, according to a study to be released this week by Alexandria research firm Delta Associates. In Rockville, the vacancy rate is the highest in the region at 29.4%. Delta's study found that 15 Class A, or top-tier, garden apartments were sold in the Washington area in 2003. The average per unit price of $165,181 was up from $148,534 in 2002. In Loudoun County, demand for apartments soared during the technology boom from people who wanted to live near the new firms in Northern Virginia and from others waiting for their luxury homes to be built. "In Loudoun County, everybody decided they needed some units there at the same time," said Al Cissel, a senior vice president in the residential division of Transwestern Commercial Services. "The tech market was huge out there." This rapid growth created an intense debate over high-density housing in Loudoun as the county's population doubled. The tech market crash "left a big hole in the [number of] tenants in the market," Cissel said. As companies closed or cut jobs, apartment vacancies soared. Meanwhile, new construction slowed after the tech crash. "We've had the strongest decline in the pipeline in Virginia," said Gregory H. Leisch, chief executive of Delta. The result: Some developers are beginning to build new apartment buildings. Loudoun is likely to add 2,459 Class A garden apartments in the next two years, according to the Delta study. That is almost as much as the construction predicted for Tysons Corner, Vienna, Alexandria, Fair Oaks and Reston-Herndon combined. Those five areas are likely to add a total of 2,563 units.
But there are several possible pitfalls this year, any of which could diminish the industry's generally bullish outlook. One worry is that the number of small companies looking for space shrunk last year. The strong leasing numbers came from a relatively small number of huge deals. Another reason for pause as forecasters plan for 2004 is the amount of construction in the region. Very few buildings are under construction in the region's most troubled office markets - the outer suburbs of Northern Virginia from Tysons Corner to Dulles International Airport. But in close-in markets, it is a different story. Downtown Washington had the strongest office market in the region - and by some measures, the nation - through the economic slump. So developers have largely kept building like it's 1999. According to Cassidy & Pinkard, 2.5 million square feet of office space are scheduled for completion in 2004 and 3.2 million more in 2005. Less than half of that space is leased. More DC Office Stats Tim Lemke, Washington Times 1-23 While Northern Virginia still has the highest vacancy rate of any market in the DC area, suburban Maryland showed the least improvement. Prince George's County rate of empty office space rose from 12.1% to 15.8%, real estate broker Cushman and Wakefield said in its year-end report, released yesterday. . In Montgomery County, the vacancy rate fell from 14.6% to 14.1%. More than 2.1 million square feet of office space was leased in Montgomery County, compared with about 351,000 for Prince George's County. The office vacancy rate in Northern Virginia fell from 20.5% to 17.6%. But to some real estate brokers, office space in suburban Maryland has been a tougher sell, because it lacks the convenience of space in the District and is $2 to $3 more expensive per square foot per year than many parts of Northern Virginia. Reston/Herndon fell from 24.1% to 19.4% vacant. Tysons Corner went from 18.9% to 17.0% vacancies. Chantilly went from 16.9% to 16.4% vacancies. Loudoun County fell from 19.1% to 15.2% vacancies. Related: Office Vacancies Fall in Washington - Washington Post
In the last three months of 2003, vacancy rates increased across the board in every market, including Boston (overall vacancy rate 11.1%), Cambridge (14.8%), and the suburbs (17.9%). Except for Charlestown, the Back Bay, and the Harvard Square/Massachusetts Avenue area in Cambridge, every part of Greater Boston had double-digit vacancy rates. The only market to see gains was the Back Bay, where the vacancy rate dropped to 8.2% at the close of 2003, down from 10.2% for the same period in 2002. The area around the junction of Interstate 495 and the Massachusetts Turnpike had the highest suburban vacancy rate, at 20.8%, an increase from 19.6 percent in fourth-quarter 2002. The lowest suburban rate was in the area Spaulding & Slye Colliers calls 495/South, at 10.9%. Closer to Boston, the hardest-hit locale was the Alewife section of Cambridge, where the vacancy rate reached 24.8%, up from 21.1% a year earlier. In the city, the South Boston Waterfront suffered the highest vacancy rate, 16.2%, versus 12.6% a year earlier. At the close of 2003, average asking rent in downtown Boston was $25.69 per square foot, reduced from $28.52 a year earlier. Along Route 128 and the Mass. Pike, average rent was $21.79 in the fourth quarter, compared to $25.24 at the end of 2002. Along the I-495 corridor, rent averaged $18.16 per square foot, versus $20.50 in 2002.
Within the various product classes, class "A" communities have the highest vacancy rate at 6.5%, while class "B" communities have a 4.8% vacancy rate. This correlates closely with the type of recession we had experienced, which was predominantly "white-collar" in nature. Additionally, many class "A" renters have jumped on the home ownership bandwagon which further impacted this segment of the market. Moreover, the vast majority of class "A" product was built in the more tech-heavy submarkets. The class "B" communities, meanwhile, are benefiting as a low-cost alternative in a price sensitive market in which the renters are "renters by necessity". However, with the class "A" communities experiencing reduced rental rates and higher vacancies, we believe class "A" properties offer investors significant upside as the economy recovers. The first half of 2003 experienced further rent erosion ranging from 2.0% to 5.0% depending on the submarket. Certain submarkets, however, experienced very little rent erosion with the healthiest markets being located south of Boston. Concessions are still prevalent in the weaker submarkets, albeit improved over the first half of 2003. Most of the concessions are found in the class "A" assets in the two-bedroom unit style. Despite the soft market fundamentals, the current state of the capital markets has produced record sales activity for Boston. Investors still believe Boston offers some of the best long-term investment prospects, with high barriers to entry and strong long-term rental growth potential as the economy comes back. This, coupled with historically low interest rates, has spurred investment in the region. We have seen average cap rates for class "B" assets drop to the 7.0% range and the class "A" assets drop to the 6.0% range. This compares to 8.0% and 7.5% respectively just four years ago. Approximately 3,697 units in 18 developments were delivered throughout greater Boston in 2003. The estimated deliveries for 2004 show a decline in the amount of new supply with 2,264 units in 12 communities. Beyond 2004 there are upwards of 27,000 units that are currently in the planning and permitting phases. The likelihood of all these units being delivered, however, is negligible as many developments will not make it through the permitting process and the financial infeasibility and sponsorship of these developments will eliminate a large contingency. Another limiting factor of the potential new supply is the amount of units that are being converted to condominiums. While there is no concrete source for the number of conversions, they are on the rise and represent a significant amount of inventory that is taken out of the rental pool. A June 2003 study prepared by the Cambridge Community Development Department showed that in Cambridge alone 1,261 units were converted to condominiums over the five year period ending in 2001 and that trend has only increased since then. The forecast for the multi-family market is positive. We expect to see continued gains in effective rents in the coming months as concessions continue to burn-off as the overall economy improves. We do not see the potential new supply as a significant factor in the market as many developments will not break ground.
Absorption of industrial space by companies was negative for the third year in a row. The negative absorption in 2003 of four million square feet wasn't as bad as it was in 2002 and 2001, when it was a negative 17.3 million and 48.1 million, respectively. The 2003 results indicate that the market still has a lot of space to absorb - especially with construction continuing at a strong pace. Last year "was a challenging year but [the market] saw slight improvements" beginning mid-year, says John W. Seiple, president and COO of ProLogis. "We don't think 2004 will be a year of dramatic improvement but instead a year of slow, steady improvement," Mr. Seiple says. "Demand is not as negative as it was, but the market overall is still weak," says Laura Stone, an industrial market economist at Torto Wheaton Research. "Rents are still soft, even for newer space, even though that space is leasing up," says Robert Bach, national director of market analysis at Grubb & Ellis. "Rents are still under pressure because there's still a lot of [older] second-generation space out there that's not leasing up so well." Second-generation space refers to industrial properties that are now considered obsolete due to changes in warehouse design. Souteastern Industrial Market National Real Estate Investor 1-01 "The [Southeast industrial] market may be showing signs of life for the first time in about four years," says Roger Tutterow, an economist at Kennesaw State University. Tutterow believes that the industrial market should rebound in short order. "Strong exports of chemicals, textiles and computers are fueling the South's rebound," says Pamela Zoellner, Cushman's senior managing director of Industrial Services. The Southeast will bounce back in 2004 because the same qualities that nurtured boom towns like Atlanta in the late 1990s still exist, says Patrick Henry, a partner at Trammell Crow Co. He believes that Atlanta and other Southeast cities can boast of a high quality of life, strong labor force with good infrastructure and a diverse economy. Atlanta is once again leading the nation in new job growth. The Atlanta region was expected to create 32,100 new jobs in 2003, according to Dr. Rajeev Dhawan, director of Georgia State University's Economic Forecasting Center. And in 2004, he says that metro Atlanta is projected to create 55,400 new jobs. In Atlanta, King Industrial Realty Chairman Charlie King says the city's 430 million sq. ft. warehouse/distribution market has turned the corner. The market had net absorption of 23,960 sq. ft. in the third quarter. King acknowledges that figure isn't usually something to brag about, but on the heels of two difficult years it represents hope. Atlanta led the nation in the total amount of industrial property leased and sold through October, reports Cushman & Wakefield. Two markets north of Atlanta, Raleigh and Nashville, are poised to become boomtowns in the next couple years, says Crow's Mr. Henry. The expected increase in research and development spending along with demand for research parks should benefit Raleigh. Nashville's quality of life and ability to attract young professionals have left the Music City well positioned to capitalize on the impending economic and real estate rebound.
"Unless a tenant stays in building A and also goes to building B, you will not see marked reductions in vacancy," said Ken Krasnow, Cushman & Wakefield senior managing director & head of the New York offices. Despite the absence of hiring, Krasnow believes the larger lease signings indicate a comfort level that was not present in 2002. And there are more large leases that will close during the first quarter. Unlike vacancies, average asking rents did not hold during 2003. Overall, the average rent in New York City was $40.53 per square foot at year-end, down from $42.96 at year-end 2002. But Midtown and Downtown prices have been fairly steady since the second half of the year, while Downtown is up more than $1 since mid-year. NCY Class A Office Space Ray Smith, WSJ 1-14 The average price for a high-quality office building in Manhattan hit a record $410 a square foot in 2003, even as the vacancy rate rose and rents fell, according to a new report by New York-based commercial real-estate services firm GVA Williams. That was up substantially from an average $306 a square foot in 2002. The average price nationwide for a high-quality office building, or Class A space, in a central business district rose to about $293 a square foot in 2003 from $252 a year earlier, according to Real Capital Analytics. The vacancy rate for Class A office space in Manhattan rose to 11.3% at the end of 2003 from 10.7% at the end of 2002, according to Colliers ABR Inc. Average asking rents for such space fell to $45.59 a square foot in 2003 from $47.52 in 2002.
Despite the vacancy level's recent stability, however, rents have continued to fall, although not by much. According to Reis, both average asking and effective monthly rents declined by 0.1% in the third quarter, to $952 and $884, respectively. Metro-wide concessions range from 0.5-to-1.4 months of free rent over the average lease term. The area's slow population growth - estimated at just 1.0% per year from 1998 through 2002, according to Economy.com - has been a major contributor to the area's conservative development profile. According to Reis, the average annual delivery total for the past five years ending with 2002 has been a modest 2,500 units. Sales of Chicago apartments, for which Reis reports an average cap rate of 7.3%, are brisk. When will this market begin to see significant signs of improvement? Continued weakness in employment could delay any major decrease in the apartment sector's current inventory of vacant space, which now stands at 24,000 units, according to Reis. Average non-agricultural employment here declined 1.2% from October 2002 to October 2003, according to data provided by the BLS, while unemployment is reported at 6.9% per September 2003.
Since 2000, downtown has recorded negative net absorption, and the Bayou City is on pace to finish 2003 in the red again. During the third quarter, downtown Houston experienced 351,000 square feet of negative net absorption, boosting the year-to-date total to 845,000 square feet. Its vacancy rate accordingly rose to 18.6% at the end of Q3, from 17.9% for the same period last year. The West Loop-Galleria submarket's vacancy rate remained above the market average of 15.7%, reaching 17.4% at the end of Q3, an increase from 14.3% for the same period last year. The region posted positive net absorption of 52,000 square feet in Q3, but during the first nine months of 2003, saw nearly 500,000 square feet of negative net absorption. The Class A rental rate dropped to $21.60 per square foot, from $21.73 per square foot for the same period in 2002. In Westchase, the vacancy rate was 16.4% at the end of the Q3, a decrease from 19.2% for the same period last year, according to Delta Associates, Transwestern's research arm. "The farther you go out in the suburbs, the better the markets are performing," said Louis Rosenthal, VP & leasing director for Jones Lang LaSalle Inc. Westchase is one of the few submarkets that managed to post positive net absorption this year. The submarket absorbed 96,000 square feet during Q3, and year-to-date it had consumed nearly 300,000 square feet. Rents in Westchase have declined during recent months, to $21.35 per square foot at the end of Q3, from $22.13 a year earlier. The Energy Corridor's vacancy rate was 12.3% at the end of Q3, down from 13.2% for the same period last year, according to Delta Associates. The market experienced heavy absorption, thanks to several large leases. Yet even with the Corridor's strong leasing fundamentals, Class A rents dropped to $21.04 per square foot during Q3, down from $21.49 per square foot for the same period in 2002. Houston's unemployment rate dropped to 6.8% in September, down from 6.9% in August, according to the Texas Workforce Commission. The statewide unemployment rate fell to 6.5%. Chase/Bank 1 Merger Will Hurt Office Vacencies R Bivins, Houston Chronicle 1-17 The already-beat-up downtown office market could be further bruised by the proposed merger of J.P. Morgan Chase and Bank One. J.P. Morgan Chase and Bank One occupy space in seven buildings downtown. One sign they are likely to need less space is that J.P. Morgan Chase officials predicted a 7% reduction in the combined staff of the two banks after the takeover. In Houston, that could translate into nearly 500 jobs lost. The Class A downtown vacancy rate has gone from a very tight 3.25% at the end of 2001 to 19% at the end of 2003, according to Trione & Gordon/CRBE.The average rent for Class A space was $23.05 per square foot at the end of 2003, down from $25.38 per square foot at the end of 2002.
Orange County, for example, was No. 1 because it earned top-five marks in every category except employment growth. Fort Lauderdale rose in the ranking because that market is expected to see strong job growth and a significant drop in construction completions. San Francisco's rise, along with moves of eight and 10 spaces by Denver and Seattle, respectively, signals "2004 will be a year of reduced new supply" and a return to growth in employment. On the other hand, Jacksonville dropped four spots to 16th and Portland fell 10 places to 29th, even though, like Manhattan, they are expected to have low vacancies, job growth and/or rent growth. "It doesn't mean that these markets' fundamentals aren't improving," says Harvey E. Green, Marcus & Millichap's chief executive. "It just means other markets are improving faster." Marcus & Millichap's rankings for 2004 of 40 apartment markets. The rankings are from best to worst. Top 10: Orange County, San Diego, Los Angeles, Riverside-San Bernardino, Fort Lauderdale, Las Vegas, Oakland, Washington, D.C., San Francisco, Boston. 11-20: Philadelphia, New York City-Manhattan, Sacramento, Tucson, Phoenix, Jacksonville, Northern New Jersey, Salt Lake City, Chicago, West Palm Beach. 21-30: Miami, Charlotte, Minneapolis-St. Paul, Orlando, San Jose, Tampa, Seattle, Austin, Portland, Detroit. 31-40: Denver, Atlanta, Dallas-Fort Worth, Columbus, New Haven, Houston, Cleveland, Milwaukee, Cincinnati, Indianapolis.
Earnings growth: First Call expects 0 percent earnings growth for the REIT sector in 2004, compared to 8% to 9% earnings growth among the S&P 500. Revision momentum: REIT 2004 funds from operations estimates have fallen 1.4 percent during the course of 2003, while broader equities have seen upward estimate revisions of late. Taxes: REITs were already exempted from many of the benefits that could boost other stocks following the passage of the 2003 Federal Tax Plan. The plan reduced personal income taxes on dividends but most REIT stocks were already exempt from the additional tax. A weaker dollar: REITs are primarily domestic-based and will see little benefit from a weaker dollar compared to multinational firms competing with imports. Valuation: REITs are already trading at the highest relative multiple to the S&P since 1997, despite lackluster earnings outlook. Rosivach says potential catalysts for a REIT pullback include a tighter spread between REIT earnings yields and bond yields and increased equity issuance. More Projections Tim Lemke, Washington Times 1-03 High vacancy rates may cause REIT stocks to become depressed in 2004. "There is now some concern about REIT valuations in some quarters," said Keith Pomroy, a senior analyst with SNL Financial. "If our current prognosis for the economy remains unchanged, with some decent [gross domestic product] growth from here and moderate job growth at least in the second half of next year, we would argue that the [S&P 500] is likely to outperform the REITs," Morgan Stanley analyst Greg Whyte said at a recent round-table discussion organized by Real Estate Portfolio magazine.
The industry is finishing a year that saw it rebound from a dismal 2002. The NAREIT Equity Index, which tracks returns from 50 companies, is up nearly 34% thus far in 2003, compared to gains of around 5% for 2002. "If our current prognosis for the economy remains unchanged, with some decent [gross domestic product] growth from here and moderate job growth at least in the second half of next year, we would argue that the S&P [500] is likely to outperform the REITs," Morgan Stanley analyst Greg Whyte told the NAREIT panel. The S&P hasn't outperformed the REIT index since 1999, an especially difficult year for REITs. The index was down 6% as investors favored the big returns from tech stocks over real estate.
After looking at 44 non-mortgage REIT offerings completed in 2003, Whyte noticed that although the offerings are finding takers, the uptake has been slower. In a comparable study, Salomon Smith Barney reached the same conclusion. "Recent common equity offerings have underperformed similar issuances in both the second half of 2002 as well as those done earlier this year," Whyte said. "And importantly, the stocks of those companies that have completed equity offerings have underperformed during the first 10 days by 60 basis points, and the 30-day underperformance has been 70 basis points." Quick Facts, Stats & Opinions The IPO of 16.8 million shares of Government Properties Trust [GGP] premiered Tuesday [1-27]. It invests in single-tenant properties under long-term leases to the U.S. government. GGP sees substantial demand for new office space from the government. While the federal government currently owns 77% of its U.S. office space, its new properties are increasingly being leased, the company said in its regulatory filings with the SEC. (Tiffany Kary, WSJ 1-28) [CPN 1-29: Government Properties Trust only has a portfolio of five properties totaling 250,000 square feet.] After a decade of consolidation, the 10 largest mall real-estate investment trusts now control 47% of all malls - nearly all of the 200 high-performing "A" quality properties and most of the B's. (Dean Starkman, WSJ 1-21) Only 250,000 square feet of [office] space in three buildings was under development in North Texas at the end of 2003 - the lowest level since 1995. But with almost 50 million square feet of empty buildings on the market, it's no wonder developers have pulled the plug on construction. Starting in 1996, commercial builders ramped up the local real estate market and built more than 20 million square feet of office space in North Texas. (Steve Brown, Dallas Morning News 1-18) Expansion projects worth tens of millions of dollars are under way for Dallas area malls. Dallas Galleria and Valley View Center have major projects under way. And NorthPark Center and Town East Mall say they are putting plans together. (Maria Halkias Dallas Morning News 1-02) Rental rates for top-quality office space in Austin dropped to a seven-year low in the fourth quarter, a trend being chalked up to a decade-long construction boom in the city. About 11.8 million square feet, or 32%, of Austin's 36.4 million-square-foot office market has been added since the end of 1994. The city's overall office vacancy rate inched upward to 23.3% in the fourth quarter from 23% a year earlier. The vacancy rate figures don't include the impact of a new 525,000-square-foot downtown office tower, built by Cousins that's set to open Jan. 21. The highest-quality Austin office space rented for an average of $18.84 a square foot at the end of 2003, according to real estate firm Colliers Oxford Commercial. (Bob Sechler, Dow Jones Newswires 1-14) San Diego has never experienced negative net absorption on a countywide basis, according to Burnham Real Estate Services. The county is projected to add 126,148 new jobs over the next four years, an annual average of 31,537 jobs and a substantial improvement over the past two years. Stath Karras, president & CEO of Burnham Real Estate Services, expects the job growth will contribute to an improved commercial real estate market. Based on job growth projections, Burnham estimates that 3.9 million square feet of office and industrial space will be absorbed each year for the next four years. According to Burnham, the market is in "almost perfect supply and demand balance" given the available supply of 16.1 million square feet. (Jennifer Duell, CPN 1-11) Midwest Retail Update: In Chicago, the shopping center vacancy rate has declined to 9.2% from 11.1% at year-end 2002, according to CB Richard Ellis. In Cincinnati, the retail vacancy has decreased from 12.8% to 11.2% - the first decline in four years. In Minneapolis/St. Paul, retail vacancies registered a meager 5.5%. Average asking rents are $18.33 per sq. ft., up from under $17.50 per sq. ft. a year ago. Some 18 retail developments totaling 2.7 million sq. ft. are now under construction in the Twin Cities -.high by historical standards. (National Real Estate Investor 1-01) The office sectors' national vacancy rate rose to an average of about 17.1% in 2003, from 16% in 2002, according to Reis. The 2003 rate is the highest since 1993, when it was 17.3%. The average national apartment vacancy rate rose to about 6.9% in 2003 - the highest level since 7.2% in 1988 - from 6.3% in 2002. The industrial vacancy rate rose to 11.8%, the highest since Reis began tracking the market in 1980. Industrial vacancies were 11.2% in 2002. A record $4.5 billion flowed into real-estate mutual funds, which hold the stocks of publicly traded REITs, as of Dec. 23, 2003, according to AMG Data Services. About $3.4 billion was invested in real-estate mutual funds in 2002. Real-estate investment trusts returned 37.5% to investors in 2003, up from 3.6% in 2002, according to the Morgan Stanley REIT index, marking the fourth straight year REITs have outperformed the S&P 500-Stock index. Stocks of public REITs trade at 12.5 times the next four quarters' earnings, above their historical average multiple of 10.2 times, according to Lee Schalop, an analyst at Banc of America Securities. "That suggests there's more downside than upside for REITs in 2004," he says. (Patrick Barta & Ray Smith, WSJ 1-02) SNL Financial says its SNL REIT Index returned a total of 37.5% in 2003, up significantly from the index's 2002 return of just 4%. It also tops its previous annual return record of 35.9% set in 1996. SNL Financial says investors were consistently bullish on REITs throughout the year. Among individual real estate investment sectors, health care REITs had the best year, up 56%. The report shows even the worst performing REIT sector came close to S&P 500 returns in 2003. SNL's Multifamily REIT Index rose 25.6% in 2003, compared to a 4.2% loss in 2002. (Jeff Clabaugh, Washington Business Journal 1-05) The Morgan Stanley REIT Index rose about 150 points, or 36%, in 2003, outperforming the S&P 500 for the third consecutive year. The index rose 3.5% in 2002. (Tim Lemke, Washington Times 1-03) [Barrons reports that the average real estate mutual fund returned 36.75% in 2003. Those funds returns 4.15% in 2002. Some real estate mutual funds own a portion of non-REIT stocks - like home builders.] Florida-based Rayonier Inc., a wood-products company with extensive timberlands in Western Washington, announced in August plans to become a real estate investment trust in January. Rayonier owns 2.1 million acres of commercial forest, including 375,000 acres in Clallam, Grays Harbor, Jefferson, Lewis and Pacific counties of Washington state. One other wood-products company has converted to the REIT structure. Seattle-based Plum Creek Timber converted to a REIT in 1999. (Puget Sound Business Jouranl) Update: Second Experiment in Stock Picking 1-29-04 A sector balanced portfolio is summed and compared with the average of two REIT index ETF's: ICF [Cohen & Steers Realty Majors - the top 30 REITs by market cap] and RWR [the REIT Wilshire Index]. The first experiment went from Nov 02 to Oct 03 and this experiment began at the end of April of this year. NOTE: ICF and RWR dividends were added on 12-24, but ICF appears to be having a second special dividend to be paid in December. So their combined gains may still be slightly understated. As of 1-14-04, the IFC dividend is listed as "to be announced". Earnings Guidance: CARS expects 2004 FFO of $2.52 to $2.56 a share, up from its prior guidance range of $2.47 to $2.52 a share. Thomson First Call currently targets FFO of $2.51 a share for the year. On 1-21 CARS increased its quarterly dividend to $0.4165 from $0.4140. The new annual rate is $1.666 per share. CARS also reaffirmed its 2004 annual dividend guidance of $1.70 per share. The company expects 10% to 15% of that dividend to be a return of capital. RSE expects FFO of $4.10 to $4.20 per share in 2004. The forecast trails analysts' average expectations for FFO of $4.27 a share, with nine estimates ranging from $4.20 to $4.35. RSE increase in its common stock cash dividend to 47 cents a share from 42 cents. RSE expects that only 30% of 2003's cash dividend will be subject to the standard income tax rates, while the rest will qualify for the lower 15% federal tax dividend rate instituted in mid-2003. AMB gave 04 FFO guidance of $2.30 - $2.40 in their Q4 conference call on 1-14-04. The current consensus estimate is $2.34.
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