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Capital and public markets will reign in 1998.

The overriding characteristic of the 1998 real estate market will be magnitude. There will be big buys at big prices by big entities that will be bigger before the year ends. Once again, the magnitude of available capital will spur acquisitions of individual properties, portfolios and entire real estate operating companies, both private and public, according to the annual Korpacz Real Estate Investor Survey.

REITs will be the major players in the real estate market, accelerating their aggressive stance as acquirers of property. In addition, as they strive for greater mass - in market capitalization, numbers of properties and amount of cash-flow - they will acquire assets in bulk through mergers and acquisitions of other REITs, as well as private companies.

The transition of real estate from a primarily private industry to a significantly public market industry is likely to accelerate in 1998, transforming the way real estate is owned and managed. The trend for commercial service firms to go public will continue, and real estate itself will increasingly be transferred to public company ownership.

These are some of the findings in the annual Real Estate Market Forecast published by the Korpacz Real Estate Investor Survey. The forecast is based on an extensive questionnaire as well as proprietary interviews with prominent real estate market players. More than 70 active investors participated.

"Hand in hand with movement toward public ownership is consolidation of real estate companies, another trend that will escalate in 1998," said Peter F. Korpacz, MAI, publisher of the Investor Survey. "The real estate industry is at the beginning of a massive wave of consolidations, which will end in real estate ownership in the hands of a small number of companies."

Economic Conditions

The Korpacz investors mirror economists forecasts of the national economy for the coming year. Nearly 90 percent of respondents think the national economy will grow in 1998. Although, like other market watchers, they look for slower growth than in 1997, they express concern that unexpected strong growth will trigger a significant increase in interest rates. Consequently, interest rates top the list of economic issues that will affect real estate this year. In rank order, the issues are: interest rates; stock market conditions; job growth; inflation; technology; corporate/personal debt; business mergers, federal, state, and local taxes; deficit reduction; and foreign competition.

Conventional wisdom says that low inflation in the presence of low unemployment cannot persist, and the inevitable pressure on wages will cause the Federal Reserve to raise interest rates to contain inflation. "However, the current economic expansion has not followed the pattern of earlier post recession periods, so predictions about its future direction are harder to make," said Korpacz. "One thing is clear; the Fed will have to maintain the fine balance between interest rates and economic growth.

Buy or Sell?

"The buy window will be open for another year," Korpacz said. Still, nearly all survey respondents say that 1998 will be a better year to sell than to buy property. Prices are at or near replacement cost in many markets. "While it is impossible to predict how much farther they might rise," Korpacz said, "most investors perceive that the time might be right to cash out."

REITs will continue to lead the market in acquisitions, according to 95.9 percent of respondents. "Make no mistake, however," said Korpacz, "pension funds will likely dominate in bids for top-tier individual properties. It is in the $10 million to $15 million deals that REITs often outbid pension funds and others."


Capital will continue to flood the market in 1998. The public markets will be the primary providers of both equity and debt capital; REITs on the equity side and CMBSs on the debt side. Ranking of capital sources is shown below: Equity - REITs, pension funds, opportunity funds, leveraged equity investors, foreign investors, owner-users, individuals and life insurance companies. Debt - CMBSs, life insurance companies, domestic banks, pension funds REITs, credit companies, non-REIT securities and foreign banks.

Debt capital providers are disciplined now, a condition investors hope will continue throughout 1998. "Most lenders are not taking too much risk and still require that potential new construction be 60 percent pre-leased before they will approve a loan, noted Korpacz. An additional factor in capital discipline is the prominence of public markets. REITs, CMBSs and conduits are rated by agencies, whose underwriting criteria can cap risk.

"Nevertheless, in a reel estate market such as exists now, there is always a drive to put money out there," Korpacz said. "This makes those of us who have lived through a cycle or two a bit nervous. "

Most Promising Property Types

Downtown office buildings are top investment targets. "As leasing has improved in property markets, investor interest has rolled through them, "Korpacz said. "Now, with lower returns from other property types and better conditions and significantly better prices in CBDs. investors are turning to downtown." The forecast value change rate in the national CBD office market is 8 percent.

Traditionally strong CBDs, including New York, Chicago? San Francisco, and Boston, will attract the most attention. "CBDs with greater perceived risk, such as Dallas, Houston, and Los Angeles, will appeal to some buyers,' Korpacz observed, "but the comeback of some such downtowns is due to the strength of their suburbs, not to their own fundamental viability."

Survey respondents rank the promise of property types as follows: CBD office buildings; suburban office buildings; industrial R&D; industrial warehouses; development land; neighborhood/community centers; hotels/resorts; suburban apartments; urban apartments; regional malls; and power centers.

Office: Because most of the highest quality product has been bought - and at prices near replacement cost--suburban office transaction activity in suburban markets may slow. Possibly the play may turn to Class B product in the suburbs. The forecast value change rate for suburban office product is 3.9 percent.

Industrial: The long run in the industrial warehouse market has exhausted the supply of existing product for purchase. In addition, prices are at or above replacement cost across the national market. Cap rates have dropped significantly over the past year. Consequently, for the first time, investors put the industrial R&D segment ahead of industrial warehouses as offering more promising investment opportunities in 1998. Many prefer R&D properties in recognized high-tech areas such as metro Boston and Silicon Valley. The forecast value change rate for industrial property is 3.2 percent.

Retail: Both REITs and institutional investors are interested in acquiring well-located neighborhood and community centers anchored by the market-dominant grocer. Regional malls and power centers are the two least desirable property types. The forecast value change rates in the national strip center and national regional mall markets are 2.6 percent and 2.5 percent, respectively. Average power center values are expected to decline 3.4 percent.

Hotels: The consensus of the hotel investors who participated in our forecast is that overall the national hotel marker will remain robust into the foreseeable future.' said Korpacz. The fundamentals are in place to create demand for hotel rooms. Office development is now back in vogue, and with new office space, there are new demand generators.

The best hotel investment opportunities this year will be in the luxury segment, followed by full-service hotels. Luxury hotels and resorts are the properties in which investors perceive the widest spread between replacement cost and value. In addition to the high hurdles for new construction, many luxury and resort properties enjoy unique or dominant locations, which makes them difficult to replace. The forecast value change rate in the national full-service, economy/limited-service, and luxury hotel market segments are 6.9, 1.7 and 8.2 percent, respectively.

Multifamily: A solid economy and strong projected job growth over the next several years are the bases for investors' persistent enthusiasm for apartment investment. In addition, lifestyle trends are also generating renters, as people tend to wait longer to buy homes and empty-nesters choose the convenience, service and amenities that go with renting.

The national apartment market is, by and large, in equilibrium, despite a considerable amount of construction over the past several years. The current building cycle has been much more disciplined than in the last decade. As markets have started to become overbuilt and absorption has slowed, construction has decreased. Korpacz survey respondents are concerned, however, that investment demand, especially from REITs, will trigger a less disciplined development environment. The forecast value change rate in the national apartment market is 2.1 percent.

Where to Invest

One of the last areas in the nation to ascend from the depths of recession. Los Angeles now tops the list of metropolitan areas that offer the best real estate investment opportunities. Following L.A. are Seattle, San Francisco, and Chicago.

"The common thread among the most promising metropolitan areas is that their outstanding attributes translate to jobs," Korpacz said.

Los Angeles' spectacular economic recovery was led by the entertainment industry, but now the more traditional industries manufacturing, defense and aerospace, as well as their related industries--have kicked into high gear. These, along with apparel, export-import and others, are expected to generate job growth in the Greater Los Angeles area approximately double the national average over the next two or three years.

Seattle is in the midst of a impressive economic expansion. As welcome as Boeing prosperity is, the surge in other industries now limit Boeing's impact in the economy. High-tech industries employ more people than aerospace. These, along with international trade and other industries, will account for projected employment growth of approximately 3.5 percent next year.

Anchored by high-tech and biotech industries, San Francisco and the Bay area are thriving, a condition that should last into the foreseeable future. In addition, there has been a recent resurgence in financial services, and an influx of multimedia and publishing companies into the area. The signs of a boom town are evident in such projects as the $856 million international terminal that is under construction at the San Francisco airport; a new convention facility to be built near the Moscone Center; and new hotels planned for downtown.

Chicago has a widely diversified economy. Years ago it moved away from reliance on manufacturing to service industries and exports. The MSA is thriving, and as a result, retail, industrial, multi-family and office property are all good investments for 1998. The suburban office market, which has experienced tremendous transaction activity over the past several years, will continue to be a hot market, but investor focus is expected to shift to the rapidly heating downtown office market. Chicago land is also a target for both industrial R&D and warehouse investment.

The Korpacz Real Estate Investor Survey is published quarterly by The Korpacz Company, Inc.
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Title Annotation:Korpacz Real Estate Investor Survey
Publication:Real Estate Weekly
Date:Feb 4, 1998
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