Survey verifies real estate turn-around.

Single digit improvements in market fundamentals coupled with double digit increases in construction and financing volume suggests 1994's real estate rebound should be viewed with caution according to an annual review of U.S. real estate conducted by Coopers & Lybrand L.L.P.

The report surveys industrial property, retail real estate, hotel markets, single/multi-family housing and office markets focusing analysis on vacancy rates, construction starts, rents and loan delinquencies and commitments.

"From an investment standpoint, the improvement in property fundamentals in heartening," says Patrick R. Leardo, National Real Estate Industry Chairman. "However, for those who have lived through real estate cycles before, numbers on the capital side of the equation should raise some questions to investors."

Industrial

The industrial property market grew in tandem with the general economy in 1994. Nationwide increases in employment, especially manufacturing employment, industrial production and manufacturing capacity, which reached a decade high, created strong demand for industrial space. Vacancies dropped 10.8 percent to 7.4 percent, and rents responded modestly, increasing 3.2 percent to $4.45 per square foot. Compared to other property sectors, much of the warehouse construction market continues to be built-to-suit, moderating potential mismatches between supply and demand.

Moving forward, technologically advanced warehouses with sophisticated just-in-time inventory methods and computerized storage and retrieval systems have further hastened the obsolescence of small, simple warehouse space. Warehousing at seaports, markets with strong ties to Latin America and the Pacific Rim and markets expected a NAFTA-related boost are all strengthening. In contrast, the research and development market which, overall, comprises 12 percent of total industrial space, continues to struggle with government spending cutbacks and military-base closures.

Retail

Compared to 1993, construction made a dramatic turnaround in the retail sector. In 1994, new shopping center construction grew by 14 percent, the first time annual construction rose in nearly a decade, and five new regional malls were started compared to only one large center in 1993. Even more noteworthy, construction in free-standing stores grew by 24 percent adding nearly 222 million square feet. Construction of free-standing stores to house big-box retailers outstripped construction of shopping centers by more than four to one.

Overall, the continuing transformation in the retail real estate market roiled this industry in 1994. While top performing regional malls still dominated, under performers are continuing to segment into value centers, entertainment environments and fashion centers. Power centers, typically comprised of four category killers and a value retailer, are fast becoming the characteristics form of destination retail and continue to plunder department store sales.

Last year, retail sales grew by 7.8 percent, but retail durables outsold nondurables by a ratio of nearly three to one. Automobile sales, not sold in shopping centers, exploded at an annual growth rate of better than 15 percent, while apparel sales, the mainstay of regional malls, languished at approximately 1 percent. If last year's modest 2.6 percent inflation rate is taken into account, apparel sales actually declined.

Hotel

The hotel market rebounded resoundingly in 1994. Room occupancy rose to a decade high in the third quarter and average daily room rate growth surpassed inflation for the first time since 1988. Hotel starts rose for the second straight year, reflecting a rise in casino-related activities in Las Vegas.

Hotel sector loan delinquencies declined 17.9 percent to 9.2 percent compared with 1993. However, 1994 new loan commitments also declined by over 42 percent to $212 million.

From an investment perspective, although the rise in interest rates postponed the debut of several hotel REIT IPOs, hotel acquisitions are again a favored asset class. Competition from economy/limited service lodging facilities has produced a shortage of chain-affiliated products in choice markets, and new construction could erode this segment's attractiveness. Interest has been transferred to full-service hotels, but fewer investors can afford them. A dearth of new construction for full-service hotels offers buyers some protection.

Single-Family Housing

The bull of the real estate market, single family housing buyers mostly ignored last year's Federal Reserve interest rate hikes as construction starts increased 6.3 percent. Buyers opted instead for adjustable rate mortgages to meet underwriting requirements. However, toward the end of 1994, resale volume and inventories of unsold new homes both showed signs of slowdown, and mortgage origination, down 23 percent over last year, stalled badly, indicating an imminent slowdown in single family construction starts. In 1993, mortgage refinancings accounted for $400 billion in origination.

Multi-Family

Across the board, multi-family rental properties turned in the best property performance in recent years. As measured by the Russell-NCREIF Index, apartments were the only segment to demonstrate capital appreciation in 1994 and construction starts skyrocketed, increasing by 60 percent over the previous year.

At 259,000 units for 1994, construction starts are still well below their mid 1980's peak and, more importantly, below the 350,000 level deemed necessary to house one-third of households who are renters.

Combined with a proliferation of nontraditional households, high for-sale prices in some places, falling single-housing values and rising mortgage rates, comparatively low construction starts are keeping demand for rental housing high. However, housing starts would be much lower in the absence of the permanent reinstatement of the government's Federal Low Income Tax Credit Program.

Administered by the states as part of the tax code, the $325 billion program allocates credits to developers for producing housing at rents pegged to a percentage of state median incomes. According to the National Council of State Housing Agencies, between 1987 and 1992, 331,409 units and 9,782 projects were built as a result of the program, and another 80,000 units are estimated to come on line in 1994. Clearly, the nearly 70,000 units completed annually account for a significant number of completions in recent years.

Office

Although corporate downsizing has tempered space taking, there were a number of bright spots in this sector. Office markets with strong manufacturing growth stood out as local office economies expanded to service industrial growth. Vacancy rates in the suburbs dropped below CBD rates nationwide for the first time, and, although new office construction is still mostly built-to-suit, a few southeastern markets, notably Charlotte, reported some speculative activities.

Overall, construction starts increased 16.6 percent compared with 1993, and vacancy rates, at 17 percent in 1993, decreased to 15.5 percent last year. Loan delinquencies decreased by 28.4 percent compared with 1993, while new loan commitments increased by 20.3 percent.