Investment conditions strengthen as capital floods market.

The steady improvement in commercial real estate is enticing a broadening pool of investors to pursue all types of property. In general, rents and occupancies are rising, although the degree varies among property and geographic markets.

"Under current conditions, real estate promises cash-heavy institutional investors better returns than they can expect from other investments," reports Peter F. Korpacz, MAI, in the current issue of the Korpacz Real Estate Investor Survey.

Real estate transaction activity is accelerating where the number of available properties is sufficient to satisfy investor demand. For the hottest property types, such as suburban office projects and industrial warehouse/distribution facilities, investors are often frustrated as they lose out to higher bidders. "In some cases they find it difficult to understand the excitement over a particular offering," says Korpacz. "While industrial property is scarce, there are plenty of good suburban office properties available. So why the intense bidding wars? The consensus of our survey participants is that there is simply too much money chasing real estate," he explains.

"I feel like I'm driving a golf cart on the highway," Korpacz quotes one survey participant as saying. "In my experience, it's common to analyze six or seven potential investments to acquire one, but I'm not accustomed to analyzing 10 or 12 properties to get none," says the investor, who has bid on several suburban office properties recently but lost out due to heavy competition.

Investors who are seeking both downtown and suburban office buildings want to secure them while they are still available at prices under the cost to build a similar property. Competition is clearly causing prices to rise, more quickly in the suburbs than in Central Business Districts (CBDs).

"The incidences of buyers bidding up prices over asking prices for some suburban office properties, which we first noted in late 1994, diminished earlier this year," says Korpacz. "Now it is more the rule than the exception. Only in hindsight will it become clear if today's buyers are overpaying," he adds.

Although market conditions may seem to warrant the future cash flow assumptions on which the bids are founded, few properties are certain to perform as forecast. "The possibility is that the market is experiencing an interesting but short cycle, and in two or three years, some of these properties may come rolling back because they may not work out as anticipated," Korpacz concludes.

Rent Spikes

In forecasting income from office buildings where current rents are still low, many investors are applying "rent spikes" - an increase in market rent that is markedly higher than the general inflation rate. "More than half of our survey participants are factoring spikes into their analyses of some potential acquisitions," reports Korpacz.

However, most investors who are using rent spikes are extremely cautious in doing so. "Every one of our survey participants qualifies that spikes are heavily dependent on market conditions and are appropriate only on a specific property and market or submarket basis," says Korpacz. There must be hard evidence of a market comeback, such as a diversified economic base, job growth, good current absorption, and a strong indication of higher rents.

This quarter, 60.2 percent of participants in the Korpacz Survey say that they are using spikes. The last time Korpacz reported on this issue (third quarter 1994), slightly more than 50 percent were applying spikes. The highest reported rent spikes are in the Manhattan and Washington, D.C. office markets.

Buyers

Domestic pension funds and foreign groups are among the investors pumping a tremendous amount of capital into real estate. German and British investors are eager to acquire U.S. property. The strength of the German mark compared with the dollar is a significant factor in recent German acquisitions. Dutch investors, as well as other Europeans, are looking at REITs as a relatively easy way to start off investing in U.S. real estate.

Europeans tend to prefer property east of the Mississippi River, and downtown office buildings are their first property preference. They avoid suburban office properties "because they don't understand suburbs," says Korpacz. Their preference for East Coast cities, including Manhattan and Boston, is based on familiarity and proximity. In addition, they are put off by the possibility of earthquakes on the West Coast.

Asians, veterans of earthquakes, are buying property on both coasts. Investors include those from Singapore, Hong Kong, and most Pacific Rim countries. The Japanese continue to be sellers, not buyers.

Investors who are seeking downtown office buildings prefer those in cities that are economically vital or have reasonable potential for a strong comeback. The characteristics they look for include sound infrastructure and transportation systems, good retail and mixed use, and vibrant cultural and recreational facilities.

For both CBD and suburban properties, investors like Atlanta, Boston, Denver, New York, Minneapolis, Phoenix, Seattle, and major Florida cities. Suburban office investors are interested in most major metropolitan areas, among them Chicago, Dallas, Houston, San Francisco, and Washington, D.C. Other cities named include Cincinnati, Cleveland, Pittsburgh, Portland, and San Diego.

Some investors are shifting their interest in office properties in the Washington, D.C. area to Maryland and Virginia suburbs. They are becoming reluctant to purchase office buildings in the District itself because of severe budgetary and social problems.