NEW YORK, Oct 17 (Reuters) - Commercial real estate investors are braced for a tougher year in 2008, as problems in credit markets spook the sector that has enjoyed a five-year party, according to an influential report released Wednesday.
“This credit crunch has created this sense of fear in the market place, and the big question for 2008 is: How big will the hurt be?” said Jonathan Miller, author of Emerging Trends in Real Estate.
The report, sponsored by PricewaterhouseCoopers [PWC.UL] and the Urban Land Institute, is based on interviews with about 600 real estate investors, developers, property company representatives, lenders, and brokers.
Providing the U.S. economy does not slip into recession, respondents said they expect 2008 returns in the mid to high single digits, and flat to low price appreciation.
“Full recession — mid to low single digits income, possible value loss,” Miller said. “We’re definitely returning to the mean. Returns in real estate have been just been out-sized in the last five years.”
Respondents said as some investors come up short repaying their debt in 2008, they could profit from their rivals’ problems. They said 2008 would be the year to hold on to stable rent-generating properties. Real estate in port cities key to global trade, such as New York and Seattle, should also prosper.
They also said they expect publicly traded real estate investment trusts (REITs), which have lost 7 percent of their value this year, to rebound as their dividend yields become more attractive in 2008.
“Public REITs are going to be a good buy next year,” Miller said. “They’ve taken some lumps. So will mortgage company stocks, but they make take some time.”
Environmentally friendly “green” buildings also will be on investors’ lists.
Commercial real estate has enjoyed soaring returns over the past five or so years during a boom fueled by cheap debt. Meanwhile, rents have climbed and vacancies fell while escalating building costs kept the supply of new office buildings, hotels, shopping centers, and distribution centers relatively constrained.
The cheap debt kept the price of even low-occupancy buildings climbing as investors using mounds of debt sold buildings fast and cashed in on the rapidly rising prices.
But the music stopped this year as problems in the subprime residential mortgage market shook investors who buy mortgages and mortgage bonds of any type.
Although the fundamentals of commercial real estate remain relatively healthy, the problems in the residential lending market made all borrowing more expensive and drove highly leveraged buyers from the market.
REITs, pension funds, foreign investors, and even some well-funded private equity groups are expected to pick up the slack in 2008.
“Traders, speculators, the people who were buying on a lot of leverage and overpaying over the past year, year-and-a-half — ouch. Could be some problems there,” Miller said, speaking to a group of more than 100 real estate professionals in New York.
Respondents said they believe more expensive financing will push up capitalization rates — the yield on the first year of ownership — which means that prices are expected to soften.
They see cap rates rising by 0.27 percentage points to 0.49 percentage points, depending upon the type of property.
“If you’re leveraged and operating income isn’t doing so good, a 49 (basis point) increase could be not very comfortable territory for you,” Miller said.
Investors also will demand greater unleveraged internal rates of returns over the course of a 10-year investment, the report showed.
Respondents said they believed investment prospects for warehouse and distribution centers and apartments would be good, while that of retail properties would be fair.
That bodes well for REITs such as warehouse and distribution center developers ProLogis (PLD.N) and AMB Property Corp AMB.N and apartment owners AvalonBay Communities Inc (AVB.N) and Essex Property Trust Inc (ESS.N), said Amos Rogers, managing director of Tuckerman Group. (See www.reutersrealestate.com for the new global service for real estate professionals from Reuters) (Editing by Phil Berlowitz)