PPR/Dodge momentum index: real estate market at, or near, bottom.

As the national economy continues on a path of modest recovery, it has become more evident that real estate markets are either already at, or at least near, the bottom of this cycle. Construction deliveries continue to moderate, and demand, while still very weak, has improved steadily since hitting a nadir in the latter half of 2001.

As employment growth continues to improve (it has been positive for four consecutive months as of August) in the quarters ahead, strengthening demand will drive vacancy rates lower as construction remains modest. Also indicative of the bottom of the cycle is an increase (albeit mild) in development momentum of construction in the early planning phases, from last quarter's and last year's levels.

The PPR/Dodge Momentum Index tracks the quarterly movement of projects in the development pipeline before they reach the start phase. Below is a summary of the development momentum in the five major property types through the second quarter of 2002.

Development momentum was positive for four of the five major property types, with hotel being the only (and not surprising!) exception. However, it is important to note that this forward momentum is in the nascent stages.

When aggregating the total for all five property types, development momentum is still significantly down from the peak levels reached in 1998-1999. Apartments continued to boast strongly positive momentum, while office momentum is beginning to slowly increase after a sharp deceleration at the end of 2001, when construction shut down rapidly. Retail and warehouse momentum turned mildly positive this quarter, while the hotel property type exhibited little change and remains the weakest of the five property types.

Multifamily momentum, which has been the strongest of all the property types over the recent history of the Index, increased slightly from its pace last quarter. Strong capital flows to multifamily have fueled a surge in activity over the last several quarters. Attracted by the low historical volatility of the apartment market, a flood of riskaverse capital has flowed to the sector, driving down cap rates for acquisitions and new development. Markets that have seen a swell in interest also experienced a strong rise in momentum over the last quarter, including Chicago, Washington D.C., and Los Angeles. On the flip side, struggling markets including Portland and Seattle have had very slow momentum. Vacancies in both of these markets have escalated to historical highs over the last quarter.

Office momentum has begun to come back at a disciplined pace after plunging to historically low levels at the end of 2001. While net absorption remained negative in the second quarter, it was the smallest demand decline since the end of 2000. In addition, the amount of sublease space put back on the market has slowed to a trickle. Vacancies increased, but edged up by just 0.6% from the first quarter to 16%, the smallest quarterly increase since fourth quarter 2000. Construction is still down significantly from the levels of the last several years. Office construction starts were down 29% year over year as of July, and momentum was barely positive this quarter.

New York led the pack with the strongest momentum, as reconstruction plans move forward for the downtown area. Momentum in San Diego, Dallas-Fort Worth, and Detroit also increased by a smaller margin. Markets significantly affected by the tech wreck, including Boston and San Francisco, continued to see a drop in momentum.

Retail again proved to be a steady performer, with little movement from last quarter's levels. Resilient consumer spending has been a major factor in keeping the overall market healthier and it has also lended to relatively steady development patterns. St. Louis, Jacksonville, and Philadelphia were among the markets with the strongest momentum. Still coping with a slowdown in tourism, especially from Japanese tourists, Honolulu's momentum fell over the last quarter, as developers remain cautious.

With a steady increase in industrial production since the beginning of this year and inventories at ten-year lows, warehouse development momentum was up slightly in the second quarter, moving into positive territory, and is expected to rise in the near term.