Real estate investing: do the experts agree?

Those professionals who pursue a serious business practice make it their priority to participate in local, regional and national conferences and read all relevant publications specific to our trade.

The 59th Annual Review and Forecast reported in February 2005:

"Don't expect boom times in 2005 say the experts. Until employment growth soars, the industry can expect a solid but unspectacular year."

In that same issue, Real Estate Forum reported the following: "In spite of the lack of dramatic job growth, real estate was the investment of choice in 2004. Normally in real estate, performance and revenue are important because that's what generates value, because value is a multiple of NOI. You create value one of two ways, either by income going up or by cap rates going down. Cap rates have gone down so much that, in effect, we've seen the benefits of increased value without increased revenue due to a job recovery. If job growth continues slowly but surely, it should just have a multiplier effect in the year ahead."

"The biggest problem facing debt and equity players in 2005 will probably be the shortage of deals. And if you thought the competition was high last year, the experts say you ain't seen nothing yet."

Other experts have more to say:

"Despite stagnant fundamentals in most commercial property sectors over the past three years, the hyper-competitive investment environment sent price tags soaring and pushed cap rates to record lows. Now, as the economic recovery and subsequent real estate rebound gains traction and operating income improves, will prices move up even further? According to investment experts, price tags should hold steady and may even rise, although there's little room for further cap rate compression."

"The entire investment market has taken a shift to lower cap rates. I don't think we're going to see 9.5% cap rates for quite a while."

"The slow and steady improvement that we have seen in the office market recently will continue in 2005."

"Due to the improving fundamentals in most markets, new construction is on the rise. Beginning in the third quarter, we saw spec construction shoot up by about 20 million sf and this continued into the fourth quarter."

"Yet office space supply hasn't been the greatest problem. It has been the lack of demand. Rising interest rates should equate to a stronger economy, which means the employment situation is strengthening. So, if there are rental rate increases, people can easily pay it because they have the capital. As jobs return and interest rates continue to move forward, you'll see some built-up demand."

"It is also highly likely that 2005 will be the first year in which all new construction-commercial, residential and public, encompassing everything from highways to houses and high-rises-exceeds $1 trillion. At a seasonally adjusted annual rate, this milestone was first exceeded in July 2004, and every month since then has been above that level."

"Interest rates are unlikely to hold back construction spending in 2005. While short-term rates should rise regularly throughout the year, long-term rates are probably going to remain at current levels.

The reasons for this are simple. The Federal Open Market Committee (FOMC), the part of the Federal Reserve System that determines monetary policy, has a goal of providing price stability for the US. By this, they do not mean zero inflation, but rather a rate of inflation so low over the long run that it does not influence business or personal economic decisions."

"A long-term outlook of 10-year Treasury yields in the 4% to 5% range is really good news for real estate markets. Mortgage funds should remain plentiful and cheap. Also, the decline of the dollar has made US real estate prices look like a fire sale to investors in Canada, Europe and Japan. This year should shape up as one of the best years ever for commercial real estate."

According to the Bureau of Economic Analysis of the U.S. Department of Commerce, real gross domestic product (GDP) grew by 4.4% in the United States in 2004. This was the strongest growth performance for the U.S. economy since 1999.

Over the past decade, the United States has had both the highest absolute level of productivity in the world and the highest growth rate. This has already made the United States the world's largest exporter. The lagged effects of the decline of the dollar in 2003 and 2004 should lead to a very large increase in exports in 2005. Economic growth is the sum of three factors: 1) growth in the civilian labor force, 2) growth in hours worked, and 3) increases in productivity.

The really good news here is that the undergraduate and graduate school classes of 2005 will find the best labor market in at least five years. In addition, so far this year, new claims for unemployment insurance have been the lowest since August 2002--extremely good news for the economy.

If one steps back, this boom has "bubble" written all over it, in historical terms. Typically, no asset class doubles and triples in ten years without there being some morning-after repercussions. Analogy? Maybe Wall Street, which appreciated 20% annually in the late 1990's and sent the Dow Jones Industrial Average smashing through 11,000. The morning after? Here we are midway through the decade and the Dow Jones is still under 11,000. Let's not even talk about the Nasdaq. Yet, huge pools of smart money still want to buy in Southern California. Moreover, some of the demand is "institutionalized", meaning large pension funds and other big buyers have allocated a portion of their growing fortunes for real estate. That means demand probably isn't going to go away overnight.

Even those who remember the cycles say it looks like good times through 2005, and maybe beyond. This is the best of times; there is no doubt about it. We are awash in money. We are in a perfect positive storm.

A "return to reality" has to happen. The question is when? A 5% return on real estate, given the liquidity of the investment and the friction in owning it, is unrealistic. Though the US is running a massive trade deficit, foreign flows of capital into America are very strong. Much of that money is going into real estate and everybody knows California. The housing supply cannot keep up with demand in Southern California.

The TIC buyer phenomenon appears to just be getting under way and may yet mushroom. Who knows, maybe this Southland property party isn't a one-night affair but a long holiday in the making.

So, who do you listen to?

If you approach real estate investing today with a short-term attitude, you might be surprised or disappointed. If, however, you approach real estate investing with a long-term approach like many did in the early to mid-90's, you could be on your way to a more comfortable retirement.

Tony Maniscalchi, SIOR, is President of Stevenson Real Estate Services in Glendale. For more information, please e-mail [e-mail]

Mike Maniscalchi, is Vice President of Stevenson Real Estate Services in Glendale. For more information, please e-mail [e-mail]