Investment Strategies

Commercial real estate rebounding

High-quality properties can provide investors with steady income and a hedge against inflation

Jul 28, 2013 @ 12:01 am

The commercial real estate market is forging ahead, with fresh opportunities for investors, owners and tenants. That's in sharp contrast to the state of the industry in the years after the financial crisis. Even as the economy recovered, commercial real estate lagged in many markets.

Much of that has changed recently. Owners are making improvements, tenants are seeking more-attractive spaces at the same or similar cost, and — probably most telling — investors have returned to the commercial real estate market.

Transaction volume in 2013 is expected to rise to $310 billion, from $290 billion in 2012, then rise to $340 billion in 2014 and $360 billion in 2015, according to the Urban Land Institute and Ernst & Young LLP's Real Estate Consensus Forecast, which was released in April.

The top three markets in terms of investment sales volume for 2012 were New York at $30 billion, followed by Los Angeles and Chicago at $19 billion each. Secondary markets with substantial volume growth included Austin, Texas, at 94%, Orange County, Calif., at 82%, and San Jose, Calif., at 69%, according to the CCIM Institute's Quarterly Market Trends report.

RECOVERY RATES DIFFER

However, not all markets are recovering at the same pace and many have not yet stabilized. That means buyers are still able to acquire properties below 2006-07 levels and certainly for less than the cost to replace them. Further, cost of debt is at historic lows, which is beneficial for buyers and creates more cash flow to be passed along to investors.

This has translated into opportunities for commercial real estate investors — and not just the institutional buyers with large pools of money to invest. Retail investors are accessing institutional quality real estate with much lower investment amounts by buying shares of real estate investment trusts. Both traded and nontraded REITs give investors the opportunity to purchase shares in multimillion- dollar, professionally managed real estate portfolios.

High-quality commercial real estate can provide a steady income stream and historically has been a hedge against inflation. For example, multifamily properties can increase lease rates annually or even more frequently to outpace inflation. Investors in these types of properties may benefit from these increasing lease rates.

For many investors, Class A office space, apartment communities and other in-demand properties offer an attractive long-term investment. Commercial office space vacancy rates are expected to drop to 14.8% in 2013, 14.1% in 2014 and 13.6% in 2015. Office rental rates are expected to rise by 4% for both 2014 and 2015, according to the ULI/EY report.

DEMAND TO REMAIN ROBUST

Demand and lease rates for high-quality properties are expected to remain robust. There's been little development over the past five years and properties now under construction won't be ready for occupancy for many months or years. The current positive absorption rate is expected to continue. Many tenants in office properties have multiyear leases with annual increases of 2%-3%, providing dependable rental rate increases and potentially supporting regular distributions to investors. Capital appreciation is also on the upswing.

Owners and investors in recovering markets are not the only ones benefiting. Lease rates have yet to return to pre-crash heights, and many businesses have been able to move to nicer office spaces without increasing their costs. Some have traded up to Class A from Class B properties, while others are enjoying improved work environments with more amenities in better-maintained buildings.

After the downturn, the market for higher-end commercial real estate is rebounding in a significant way; sales volume and a renewed confidence all indicate that the recovery is creating new opportunities in real estate, and investors are more engaged and optimistic.

Chuck Schreiber is chief executive of KBS Capital Advisors LLC.

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