“Don’t let availability of capital cloud judgments; demand drivers don’t exist and fundamentals need to catch up.”
That’s the opening line of the 33rd annual Urban Land Institute/PwC Emerging Trends 2012 report, which looks at nationwide real estate trends based on surveys and interviews with almost 1,000 industry leaders.
The report, which was recently presented at ULI Boston’s annual trends forum, advises that the real estate industry is facing a continuation of a long grind, with returns for the best properties leveling off from recent spurts and commodity real estate continuing in a non-recovery.
According to the report, all investment capital to date has headed for the wealth islands where business and affluence concentrate, leaving the surrounding landscape mostly underwater. Outside of the top properties in the top 24-hour gateway markets and the apartment sector, real estate has stabilized, but recovery looks stalled, and the bifurcation of “have” properties from “have-not’s” widens. Vacancies aren’t getting worse, but barely show improvement, and rents roll down as new leases are marked to market. The good news: Only one of the 51 markets surveyed failed to improve over last year, and 75 percent rate fair or better prospects, compared with only 50 percent in 2011. But the better outlook reflects markets having stabilized, rather than showing significant improvement. Not only do the 24-hour gateways along the coasts register decent prospects, but there is also a surge for markets benefiting from energy and tech-related industries, which have showed the most jobs growth.
Boston Ranks High
The wealth islands are Washington, New York, San Francisco, Boston, Seattle and Los Angeles, with Boston ranked as the No. 5 real estate market in the country. The survey’s top markets also rank as the nation’s most walkable cities, with Boston ranked No. 3 in walkability.
During a panel discussion at the Boston ULI forum, sponsored by Jones Lang LaSalle, several expert investors cited affordability as a key factor for Boston to keep graduates here and retain its competitive edge.
Steve Marsh, managing director of real estate for MIT Investment Management Co., advised that Boston not become complacent – a caution reiterated in a keynote address by Paul Grogan, president of The Boston Foundation. When asked what could jeopardize Boston’s success, Grogan replied, “It’s hard to imagine us thriving indefinitely without investing in human capital.”
The report’s author, Jonathan Miller, added, “The cities that enhance and maintain their infrastructure are going to be ahead of the others.”
It happens that the No. 1 market – historically recession-impervious Washington D.C. – is the only one of the 51 cities that did not report growth in the past year. Survey respondents still think the nation’s capital will hold up, but are worried for the first time that the federal government will cut local jobs and take the edge off the market.
Job Growth Obstacles
The headwinds standing in the way of a more traditional recovery all involve jobs, and the economy is not positioned to produce enough of them. Real estate needs jobs growth to recover.
Major obstacles include:
Global job pricing. The United States is the world’s high-cost employer competing against lower-cost countries.
Technology, which has led to greater productivity, eliminating many well-paying jobs, such as travel agents, secretaries and telephone operators.
Government debt and resulting budget cuts, which have led to job cuts in both the public and private sectors.
An aging demographic, which leads to higher health care costs and fewer workers supporting more dependents.
The global financial morass, which has been a major drain, impacting the financial industry in particular. In addition, the real estate downturn itself has staunched the need for new construction, which had been a huge jobs generator.
Adding to the job woes is what amounts to dysfunctional government. While the two parties battle over power and ideology, the country sinks without constructive policies to address problems.
Waning Return Expectations
For real estate investors, this means ebbing return expectations. How much you make going forward depends on when and where you’ve invested. If you invested in 2009 and 2010 in the prime gateway markets, it’s time to take some chips off the table. More recent investments may be able to secure some decent income-oriented returns in core properties in the best markets, but not much more, and little in the way of appreciation in 2012 or 2013.
On the debt side, expect a continuing dearth of capital flows, primarily because banks are holding back and commercial mortgage-backed securities markets have been slow to re-gear. For recent lessons learned, investors would be wise to follow the money. When it looks out of control – getting ahead of leasing and supply/demand trends –you know it’s time to retreat. Sub-5 percent cap rates should be an obvious red flag.
Stephanie S. Wasser is executive director of ULI Boston.
