Real Estate Capital Scoreboard® – May, 2014

2014-05_RECS_JerseyCity_Source_JohnOharenko

Chicago, Illinois, May 1, 2014 – Global market tensions help maintain low yielding treasuries.  At the same time, real estate investors are more optimistic about the income-property sector due to a slowly improving economy.  Real estate pricing climbs to record levels as driven by insatiable demand and low cost debt.  Market highlights summarizing the first quarter of the year along with forward looking trends are as follows:

Development Trends:

  • “You have to be dense not to understand density,” indicating that high density and mixed-use vertical development is here to stay, no longer a “smart growth” conversation.
  • “Urbanization of Suburbs” shows that long-ignored, older, infill suburban areas near public transportation desirable, as pricing differential becoming more attractive vs. urban deals.
  • Increased construction and labor costs (e.g.,  15% in many markets) creating as much as 100 basis point lower development yields, but are compensated by lower mortgage and capitalization rates.
  • Land costs driving higher construction costs, peaking above pre-recession levels keeping profits in check; however, financing sources are also recognizing developer’s marked up values during such holding periods, creating more implied equity in construction budgets.
  • Parking ratios continue declining giving way to pedestrian lifestyles, bicycles, zip cars and convenient public transportation.   Municipalities showing more flexibility with this component, helping to drive down overall construction costs.

Property Types:

  • Development Yields:  Return-on-cost range of 5.5% for major-market apartments; otherwise 6%-7% for other types of commercial properties. More retail and industrial deals in the pipeline, but office still very sparse.
  • Apartments:  New construction concerns mitigated by job growth and return to urban areas – cap rates moving down to  3% in some major markets along the coasts; otherwise 4.5-5.5% for other major markets with another 50 to 100 basis points for secondary markets.
  • Retail:  About 12% of all retail sales are now on line; nearly no new development plans for department stores; larger grocers reconfiguring stores for smaller urban footprints, responding to more independent and local operators.  The most fluid property type that’s overbuilt (suburban), yet in great demand (urban infill).  Tech companies are “humanizing” their products with stores (e.g., Apple, Tesla).
  • Industrial:  National vacancy levels well below ten percent, encouraging more new construction especially given shorter development cycles and in selective markets, spec projects are acceptable.
  • Office:  Excellent yield plays during the past couple of years, but longer-term ownership is a more cautious concern do to tenant’s demand for more efficient space.
  • Hotel: Interest rate volatility and near peak pricing.

“Everyone seems to be scrambling for certain yield opportunities. Many institutional investors are re-introducing themselves to new construction funding strategies for capturing core and core plus investment plays.  Pro forma underwriting is commonplace again,” according to Jeanne Peck of the Real Estate Capital Institute.

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