Deloitte Reports Commercial U.S. Real Estate Potentially Hits Bottom in 2010
Despite Adverse Conditions, Optimistic Investors Find Opportunities via Distressed Assets
While declining values, debt maturity and tight credit access, and stalled construction may continue to plague commercial real estate in the United States for the remainder of 2010, economic indicators point towards the potential for economic recovery this year. For investors, this environment reveals a window of opportunity in 2010 when investment in distressed assets may prove to be opportune, according to Deloitte's Perspectives on Real Estate: Uncovering Opportunity in a Distressed Market, released today.
"The Fed's Beige Book released this month indicates a nascent economic expansion, with commercial real estate lagging the overall economy as it has historically done. With the market poised for change, savvy investors with access to capital may find the time to act is drawing near," said Bob O'Brien, vice chairman and Deloitte's real estate services leader. "The flip-side of opportunity is challenge, which is especially true for borrowers and lenders who are seeking solutions to a debt problem of historical proportions. As we navigate truly uncharted territory, the point where opportunity intersects with challenge is where the answers – and winners – may be found."
According to the report, trends for commercial real estate over the next nine to 18 months may include:
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Declining real estate operations. Driven by job losses and declining consumer spending, vacancies are up and rents are down, leading to decreasing values – especially in office and retail assets. An economic recovery in 2010 could lead to an uptick in the job market and consumer spending, which may correlate in rising values spurred by greater confidence in future occupancy and rent increases.
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Debt maturity and credit access. With an uptick in value drivers for commercial real estate potentially lagging the general economic recovery by three to six months, owners and mortgage holders will likely continue to struggle with debt maturity in 2010 and beyond, with an expected increase in foreclosures and deeds in lieu. Opportunistic investors, many who raised significant capital for this purpose, are using foreclosed properties and distressed debt as a strategic opportunity to make opportunistic acquisitions and expand their real estate portfolio. Key targets approached to capitalize on these investment opportunities are banks, mezzanine debt holders, commercial mortgage-backed securities (CMBS) special servicers and the Federal Deposit Insurance Corporation (FDIC).
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Stalled construction. There will likely be almost no new construction activity in any asset class in 2010, leading to historic low levels of new construction with excess capacity in almost every asset class.
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Bottom out, then recover. Some real estate asset classes are expected to bottom out and then start to recover in 2010. Rent levels will begin to rise with job growth and increases in consumer spending and gross domestic product (GDP), although this will likely be a slow rise. Hospitality – which many believe has already bottomed out – and multi-family residential may be the first to rebound because of the short term nature of their leases, with longer-term leased assets like retail, office and industrial recovering more slowly. Single-family home prices seem to have solidified, although it could take years for home values to truly recover.
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Markets to watch. Although a handful of hospitality markets, including San Francisco and Atlanta, are expected to post positive room rate growth, the majority will need to wait until 2011 for a return to profitability. Bright spots in the office market include Washington, D.C., which has benefited from the federal government expansion, and New York, which has begun to turn around due to increased hiring at investment banks. Residential oversupply remains a problem across Miami, Atlanta, Phoenix and Las Vegas.
- Where are the investors? Despite available capital, opportunistic investors have been waiting for the market bottom, signaled by stronger employment and consumer spending. Public capital markets have shown increasing interest in commercial real estate, a trend that should continue in 2010 most notably via real estate investment trust initial public offerings (REIT IPOs) and secondary offerings. The U.S. should see a significant influx of foreign capital from Asia (especially China and Korea), Germany and the Middle East, as well as from domestic investors. Well capitalized REITs and funds will likely see increased opportunities to make distressed acquisitions, both geographically and across property types.
