From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘PWC

PWC’s Quarterly CRE Review

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PwC’s quarterly commercial real estate review just hit my desk.  I have a particular affinity for this survey-based review — it was founded about 30 years ago by Peter Korpacz, MAI, an alumni of the Real Estate Counseling Group of America and an acquaintance of mine.  PwC took it over a few years ago, and have done wonderfully with it.

The entire report, at 106 pages, is far too robust for a simple summary.  However, a key metric is the review of capitalization rate changes by property type (e.g. — warehouse, apartments) and offices by region (e.g. — Manhattan, DC, San Francisco).  A cap rate, of course, is the ratio of a property’s net operating income to its sales price.  Declining cap rates on a broad front can indicate the onset of a recession, but differential cap rate changes (rising in one market, declining in another) may suggest differing sector views by real estate investors.  By property type, this is what we appear to have today.

For example, warehouse cap rates currently average 5.27% nationally, but this represents a decline by 10 basis points just in the 2nd quarter.  Generally, this points to a favorable view of warehouses by investors — they’re willing to pay a bit more for each dollar of prospective income.  Conversely, offices in the central business district saw increases of 13 basis points, suggesting a softening of CBD office prospects.

Across various regions of the country, offices in general (both CBD and others) showed either no change or declines in cap rates, with the biggest cap rate declines occurring in Phoenix and Philadelphia.  Only Denver and Atlanta showed increases in office cap rates.

Overall, investors expect cap rates to hold steady or increase over the coming six months.  Indeed, only among CBD offices and power centers was there any sentiment for cap rate decreases.  100% of investors expect net lease properties to show cap rate increases in the coming 6 months, which portends value softening in that property sector.

We’ve used the nasty “R” word (ahem… “recession”) on occasion here at Greenfield, and PwC seems to agree with us.  They expect that the office sector will peak by the end of this year, and a large number of metro areas are expected to move into contraction during 2018 and 2019.  They expect 61% of cities in their survey to show retail property recession by the end of this year, but with some limited exceptions (Austin and Charleston).

Industrial properties, on the other hand, should fare well, with only Houston headed for recession during 2017.  They also expect 15 other markets, including Los Angeles and Atlanta, to face industrial recession by the end of this year.  Further, a large supply of industrial property is expected to come to market during the near term, suggesting an industrial over-supply for the next four years.

One bright spot is multi-family, which continues to “benefit from the unaffordability of single family homes”.  Two markets need to play catch-up (Charlotte and Denver) but other markets should fare well, with 40% of markets headed for expansion.

PWC Surveys Investors

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PriceWaterhouse Coopers does a great job with they’re quarterly survey of commercial real estate investors.  Previously known as the Korpacz Survey, after it’s founder, Peter Korpacz, the lengthy but highly readable review gives investors, brokers, appraisers, and others a snapshot of anticipated market performance both by property type (retail, office, etc.) and market (regional, and in some cases by metro area).  The most recent issue just hit my desk, and as usual it’s terrifically informative.

The headline this quarter is, “Investors Scrutinize Cash Flow Assumptions”.  As it turns out, the assumptions and resultant aggressiveness (or lack thereof) varies significantly by property type and geographic market.  For example, strip shopping centers (nationally), apartments (also nationally), and regional warehouses in the pacific and east-north-central regions are enjoying increased optimism, measured by very significant declines in overall capitalization rates.  On the other hand, 20% of investors surveyed expect regional mall cap rates to increase over the next six months, and 40% of investors felt the same about the overall Denver market.

Intriguingly, cap rates in CBDs trend lower than in the suburbs of those same cities, driven mainly by higher barriers to entry and a lack of available land downtown.  Additionally, most downtown cores in major markets provide the sort of 24/7 lifestyle and transportation alternatives that appeal to younger workers, and hence the firms that employ them.  As such, the downtown locations are viewed as less risky, overall.

Overall, vacancy rate assumptions have remained steady over the past year.  Coupled with that, tenant retention rates have also remained steady across markets.

In general, office markets remain fundamentally strong, and PWC survey respondents project falling vacancy and rising rental rates over the next few years.  Retail market conditions are improving, with no major markets currently in recession and an increasing number in expansion.  In the industrial sector, the expansion of the past few years is likely to abate, according to the survey, and a few metros may find themselves in the overbuilt state (Austin, Jacksonville, Las Vegas, Portland, and DC).  Apartments will continue in expansion in many markets, but the peak may be near, and an increasing number of markets are reported to be in contraction as 2015 turns into 2016.

As noted, the report is detailed, and this issue also features their less frequent surveys of medical office markets, development land, and student housing.  For your own copy (they come at a subscription cost, by the way) visit www.pwc.com/realestatesurvey.

PWC’s Emerging Trends in Real Estate for 2016

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Ever since PWC acquired Peter Korpacz’s excellent quarterly commercial real estate survey, they have really leveraged that theme into a great regular read.  Along with my subscription, their annual Emerging Trends just landed in my in-box, and it’s a really excellent read.  (To access a copy, just click on the link above.)  The report is a must-read for anyone in real estate, particularly in the investment or finance side.  I’ll skip to two of the summaries — one they call “expected best bets” as well as the capital market summary, to give you a flavor of their report.

Expected Best Bets — PWC recommends, “Go to the secondary markets”.  They note that gateway markets have pricing problems, while the “18-hour cities” are “…emerging as great relative value propositions.”  They particularly cite Austin, Portland, Nashville, and Charlotte.

PWC also discusses “middle-income multifamily housing,” and notes the solid business opportunities providing creative answers for what they call the “excluded middle” households.  PWC also encourages planners to re-think parking needs, in light of the changing demands of “live/work/play downtowns.”

On the securities side, PWC notes that many REITs are priced well below net asset value, providing an interesting arbitrage opportunity in 2016.

Capital Markets — PWC opens by noting, “In many ways, it appears that worldwide capital accumulation has rebounded fully from the global financial crisis. The recovery of capital around the globe has been extremely uneven. And the sorting-out process has favored the United States and the real estate industry, affecting prices, yields, and risk management for all participants in the market.”

Whew…. I’m usually loathe to quote so much from another’s work, but I simply could not have said that any better.  PWC quotes one of their survey respondents, a Wall Street investment advisor, who says, “There is going to be a long wayve of continued capital allocation toward our business….”

Survey respondents largely were split on short-term inflation, with about 40% predicting modest increases and 60% looking for stability at current rates.  However, when they look down the road 5 years, 80% of respondents look for modest increases in inflation.  Coupled with that, over 60% of respondents think both short term interest rates and mortgage rates in specific will rise next year, and nearly 80% think such rises will occur over the next 5 years.  Intriguingly, a small but significant minority — about 20%, believe rates will rise substantially over the next 5 years.  Almost no one believes rates will fall, either in the short-term or the long-term.

To sum up the capital markets view, PWC says the general spirit of the industry is positive, albeit with an eye toward risk.  Many are calling for a “long top” to this recovery, but many are also taking defensive postures by shortening investment horizons, paying more attention to the income component of total return rather than the capital appreciation component, and moving down the leverage scale.

As always, I would stress that I am citing a 3rd party source here, and nothing in this review should be construed as investment advise.  That said, PWC’s Emerging Trends is an excellent read, and I highly recommend it.