Commercial Property Values Continue To Fall
Real estate owners and investors are expecting further declines in commercial property values over the next 12 months as tenant demand weakens, rental rates decline and overall cap rates rise, according to the quarterly findings of PricewaterhouseCoopers' Korpacz Real Estate Investor Survey(tm), released last month. And some of these declines could be steep. In addition, with buyers and sellers in a stalemate, loan default rates and distressed sales are expected to rise, which some investors fear will lead to a market overcorrection, erroneously driving down values and undervaluing many commercial properties.
Overall, surveyed investors anticipate a further 10 percent average loss in value across all commercial property sectors and geographies. Among the four largest sectors, surveyed investors expect a 7.0 percent average decline in apartment values, an 8.5 percent average decline in regional malls, an 8.2 percent decline in warehouse, and an 11.4 percent average decline in national central business district (CBD) office values (close to a 12.0 percent average decline in suburban office assets).
Though Survey responses indicate that the office sector is expected to see the steepest decline in value over the next 12 months, there are regional differences. Investors expect the biggest office market declines in Dallas (17 percent), San Diego (16 percent), Atlanta (13.5 percent), and Houston (12.5 percent). In contrast, they expect the office markets of San Francisco, Boston and Washington, DC to see below-average declines.
The majority of the commercial real estate industry is expected to remain in recession through 2011, according to the PricewaterhouseCoopers survey. While a recovery is expected to start to materialize in the office and retail sectors in 2011, it will not dominate these sectors until 2012. In the warehouse and multifamily sectors, a more pronounced recovery is expected to materialize in 2011.
Buyers and Sellers in a Stalemate
Limited debt options remain a major problem for investors looking to acquire assets or to refinance existing properties, according to investors surveyed. Buyers with capital and/or access to debt said they are ready to take advantage of distressed deals, but they are not willing to pay for empty space and speculation. In addition, they believe that sellers have not yet fully adjusted their asking prices to reflect significant changes in market conditions and lending restrictions.
"The sales market is simply stalled and remains in a state of flux because neither buyers nor sellers know exactly where pricing is right now," said Susan Smith, director, real estate advisory practice, PricewaterhouseCoopers. "Investors are concerned that the industry is basing values on distressed sales which will ultimately reset the market too low. This makes for great buying opportunities, but there are limited debt options and a bid/ask pricing gap. It is a very difficult cycle for investors to be in and one of the most challenging cycles for them to get out of."
Surveyed investors believe that fundamentals in commercial real estate will continue to deteriorate, and they are concerned about the drop-off in tenant demand and growing levels of sublease space and shadow space in the office sector. Corporate America is conserving cash by returning space to the market, and the pendulum has swung in favor of tenants.
Investor anxiety is noted by the use of much lower market rent growth rate assumptions in their valuation analyses. The PricewaterhouseCoopers survey finds that this quarter, the initial-year market rent change rate is much lower on a quarter-over-quarter basis, as well as an annual basis, for all but two of the 28 surveyed markets. While the average growth rate was still positive in 18 of the surveyed markets, it was negative in ten of the surveyed office markets, which demonstrates that most investors anticipate rental rates to decline over the next year in the office sector.
The survey also indicates that overall capitalization rates are trending upward and over the next six months investors expect more of the same across all property sectors and geographic locations. The average expected increase in overall capitalization rates for the office sector is 60 basis points; however survey participants are expecting to see overall cap rates increase as much as 125 basis points in this sector.
Troubled Assets Growing on Bank Balance Sheets
As loan default rates accelerate, the amount of troubled loans on commercial real estate properties is expected to rise rapidly for the nation's banks, with small and midsized banks particularly vulnerable if they have large commercial real estate portfolios.
According to PricewaterhouseCoopers, banks should be carefully evaluating their loan portfolios and loan-loss provisions and conducting their own stress tests. It is possible that lenders will be more willing to agree to short-term extensions on loans rather than taking back assets given the lack of movement in the market.
"Troubled assets continue to accumulate on bank balance sheets, and the markets will not begin to recover until those assets are dealt with," said John Garvey, U.S. leader, Financial Services Advisory and U.S. Banking and Capital Markets, PricewaterhouseCoopers in a report issued last month entitled Stabilizing and reviving the financial system: Employing guarantee structures, "bad banks," and other mechanisms to combat the financial crisis. "Government can lead the efforts to remove assets from bank balance sheets, but history shows that private investors must ultimately purchase most of those assets to avoid a long 'run-off' period," he stated.
According to many investors surveyed for the Korpacz quarterly report, private equity investors are being slow in writing down losses and are dragging behind in terms of recognizing value loss. In contrast, the public markets have been more accepting of write-downs and will likely lead in the recovery. Globe Newswire June 2009
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