A real estate market that's improving, but not without risks.

The economic picture seems to continue to show improvement, even while there continue to be mixed economic signals. This is true both in the U.S. and abroad.

These similarities are evident for instance when comparing the US and Britain. While on a global level the two countries collaborated in the liberation of Iraq, they also experienced parallels in their economies. Each country's budget deficit is swelling; housing prices have been booming in most geographical areas, albeit with some exceptions. Similar also is that both countries' economies have seen significant decreases in interest rates over the past 24 months.

On a macro level, each country has issues to grapple with as it relates to the interest rate market.

In Britain, the concern is that consumers are being wooed by low, short-term interest rates on adjustable rate loans, and may not be sufficiently informed about the effects of possible higher interest rates in the future. In the US, consumers continue to buy homes and other big ticket items, fueled by the tax refunds, raising the question of whether, over time, households will have the ability to service their debt if unemployment numbers don't begin to decrease.

The US economy and England's do seem to be rebounding from three years of stagnation. The fate of manufacturing however cannot be dismissed. Orders for big-ticket goods at factories dropped 3.1 percent in November, as stated by the Commerce Department; contradictory data released by the Institute of Supply Management shows American manufacturing surging to its highest level in 20 years. The reader should consider that since the Summer of 2000, 2.8 million jobs have been lost in the manufacturing sector.

The Commerce Department further noted that it was the largest decline in more than a year, precipitating questions as to the stability in this sector of the recovery. Though manufacturing accounts for about a seventh of GDP, it remains the sector most attuned to the economic cycle. The question is, can President Bush and his colleagues at the Federal Reserve, with their activist responses, still revive a moribund economy, and if so, will the recovery be sustained? Government agencies, including the Department of Defense, spent in excess of 300 billion dollars from calendar year 2001 through 2003.

The income tax rebates for families, and the decrease in capital gains taxes, contributed to the buoyancy of the economy we are currently witnessing. Given these circumstances, one has to ask, what does the domestic economy look like after the post-election business cycle, once the sugar high is over?

What do these mixed signals tell us about the future of the real estate market?

For the moment, it appears as though we are about to begin again the cycle that we witnessed in 1999. The "purchase prices of entry" in the regional real estate market continue to be high. However, with the Dow on the verge of 10,500, climbing 25.3% in 2003, the froth might have begun to come off the real estate acquisitions market. The allocation of monies to the real estate market might begin to decrease, as this cross-over capital that found refuge in the real estate asset class returns to the asset classes of the late 1990's.

There still appears to be, however, a sizeable imbalance between supply and demand. On a national level, Commercial Net Realty indicates that there is still 2.2 trillion dollars worth of office, retail, and industrial properties on corporate America's books.

It is conceivable that as the stock market continues its upward climb, corporations may see merit in monetarizing some of these assets in order to create better pro-forma statements for the financial public marketplace, thus creating more of a supply of real estate to acquire. This might be yet another example of where the investor might begin to see a slight increase in properties, and less of a distance between the bid and ask of pricing.

The bottom line is that most investors, opportunistic funds and professionals involved in the creation of added value deals realize 18-24% returns might be something of the past and might not be achievable in the present regional and domestic real estate market place in the next 12-18 months.

An example of an acquisition that might not be able to create the returns witnessed in the past is that of the Metropolitan Hotel in Manhattan, acquired for 100 million dollars from the Tisch family by a group led by the Goldman Sachs Whitehall fund. Colleagues describe the acquisition as one that is hoped to create an investment return, perhaps, in the midteens, achievable by an "aesthetic redefinition" of the hotel.

The acquisition was not made as a "complete turn around of an asset", as would have been the case in the past, when there was the ability to source a different type of an asset play and hence a higher return. Instead, this is a deal that might have an incremental increase in value, more on par with the returns felt in a time period of far fewer deals trading with more capital in the marketplace than places in which to invest it.

The multi-family purchase market remains heated, even with the residential net effective rental rate in the Manhattan market seeing an increase of less than 1% rental growth in the past year. On the development side, the appetite for development deals on the capital side for New York City infill sites, as well as properties currently zoned for multi-family use, has been strong. In December 2003, Troutbrook Company, a full-service real estate development firm, was pleased to have put into contract, for sale, a prime Upper East Side future 100,000 square foot development site. Expected to close in the first quarter of 2004, the site does not offer possession, and based on the sale price of more than 9 million dollars, has a going in return of approximately 5%, unleveraged; with the deal not able to pro-forma with a market return if leveraged. As one bidder commented, "investors remember the strength of the real estate recovery in the last cycle and want to try again to be a part of it in the next recovery."

With cap rates as low as they are, investors are not blinking, and buying instead of being relegated to the side lines, acting on their concern that they will miss the appreciation of the real estate in the future years. The sense among developers who bid on the aforementioned asset was that regardless of the exact location, the Upper East Side now commands at minimum $750 PSF sales for an elevator doorman highrise condominium building due to the dearth of supply available for the ever increasing number of families looking to continue to live in the City, or those wishing to migrate back to Manhattan.

Add to the mix the echo-boom demographics and you have a diminishing supply for an ever increasing demand for housing in Manhattan. Both the for sale housing and the investor demand for all asset categories remains high.

On the development front Troutbrook is active in the acquisition of properties in the boroughs, primarily Brooklyn. The following three deals, in various stages of development for 2004, illustrate the difficulty acquiring in an ever competitive marketplace.

One of our development deals, for which we are awaiting final Department of Environmental Conservation (DEC) approval for site remediation, was bought in the last several months. Even with the exposure of not getting the necessary approvals from DEC, Troutbrook took the risk and closed on the deal regardless. Another deal, in the agreement stage, after substantial investment of time and funds, is contingent upon the relocation of tenants, and may not be executable if said tenancies are not willing to relocate or adjust their present leases. Lastly, a deal in Williamsburg, consisting of approximately 70,000 FAR build able, is in contract, but is contingent upon a rezoning of the area, which is currently undergoing ULURP and review by the NYC Department of Planning.

The deal, which went into contract almost ten months ago, awaits a decision, expected in the second quarter of 2004, as to the FAR build able allowed; Troutbrook fully expects that if it is not an FAR build able agreed to by our company and the seller, the deal will be renegotiated. Each of these deals represents a distinct risk and concern, illustrating the point that less than 18 months ago, Troutbrook witnessed almost 50% more deals that they were able to execute, with less "hair in the deal".

We expect the 2004 real estate landscape on the local, regional and national levels to offer few areas of acquisition that do not have strong competition in the acquisition of property.