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Investors lowering their return expectations. (Commercial).

ACCORDING TO CHICAGO-BASED REAL ESTATE Research Corporation's (RERC's) RERC Real Estate Report: Tough Decisions in Tough Times, investors are in the process of lowering their return expectations.

RERC's findings highlight the disconnected relationship between required and realized yield rates, and demonstrate the variation between return expectations over io-, five- and one-year time periods. In general, realized (or reported) returns remain in single digits.

The real estate world is embracing longer-term prospects of continued low interest rates, a soft economy without a jump-start on the horizon and low inflation, according to Ken Riggs, RERC's chief executive officer and managing principal. "For some time, the industry has struggled with how to properly use these 'apples and oranges,' or expected returns and realized returns. RERC's analysis helps to understand the relationship and the variables associated with it," says Riggs. "In effect, RERC's analysis offers the real estate industry a tool to determine if the market is cheap or expensive. The market is expensive right now, with expected [or required] returns at about realized returns. The $60,000-question hinges on how much of this disconnect will eventually be explained by a structural shift in low returns."

First-quarter 2003 pretax yield rate expectations reported by RERC for all property types on an institutional level are lower than at any time since before Sept. 11 2001. Even so, research indicates that while overall total returns remain in positive territory, the difference between required and realized returns is--2.76 percent for a 10-year time period,--0.01 percent for a five-year time period and--5.57 percent for a one-year time period.

Apartments, for example, which generally are considered to have the lowest risk among real property investments, have an expected pretax yield rate of 10.4 (the lowest it has been since RERC began forecasting these rates in 1989). The difference between this required return rate and the realized return rate for apartments for a one-year time period is--2.34 percent. The average difference for a five-year time period is 0.86 percent and the average difference for a 10-year time period is equilibrium, or 0.0 percent, where expectations meet reality.

However, all other property types show a negative variance for a 10-year period, indicating that over this time, realized yield rates have not met required yield rates. For a five-year time period, expected yield rates are higher than realized rates and a negative variance is shown for retail power centers, neighborhood and community centers, regional malls and hotels. For a one-year time period, all property types except power centers show a negative variance between expected rates and realized rates.

RERC's independent institutional survey respondents also have rated spring 2003 investment conditions higher than fourth-quarter 2002 for warehouse properties, industrial research and development (R&D) facilities, regional malls, power centers, neighborhood and community centers and hotels. However, first-quarter survey respondents rated investment conditions lower for apartments, central business district (CBD) offices and suburban offices. RERC's going-in and terminal capitalization rate expectations for all commercial property types also are generally 10 to 30 basis points lower than the previous quarter.

"Adjusting to the market realities at hand takes time in an industry that is slow to change its ways, but it is becoming clear that the real estate industry has to lower [its] expectations if [it wants] to compete in today's low-return environment," says Riggs. "This is not easy when market fundamentals are deteriorating at such a fast pace. It is creating an investment world of haves and have-nots, where those properties that have or can unequivocally attract tenants have value and those that suffer vacancy are being written down or written off the list to buy. To me, this is a solid sign that the real estate industry is indeed growing into a credible investment vehicle as real estate investors separate the wheat from the chaff."

More information about the spring 2003 RERC Real Estate Report: Tough Decisions in Tough Times can be found at
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Publication:Mortgage Banking
Geographic Code:1USA
Date:Aug 1, 2003
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