Near-Term Indicators Are Positive

Transactional activity for this year through September has already surpassed the record year of 2004 and does not appear to be letting up at any point in the near future. Currently $55 billion has been raised for domestic equity investment in the US, and that number does not include the use of leverage. Real estate continues to out-perform other choices and is attracting capital in an unprecedented fashion.

As a result of this enormous capital infusion, investors are willing to be more creative to place capital. Several advisors have launched new investment vehicles focused on specific alternative investment strategies. In addition to the four major investment categories of office, industrial, retail and multifamily, these investors are now pursuing such alternatives as self-storage, manufactured housing, parking garages, medical office, seniors housing and transportation-oriented mixed use properties.

Also due to the influx of capital, many investors are pursuing larger deals and are very interested in portfolios as well. According to Real Capital Analytics, 160 office properties have sold for $100 million or more and the top 20 property sales all exceeded $300 million, through the end of the third quarter. In addition, portfolio sales have accounted for 20% of the volume.From a geographic perspective, the Sunbelt and Midwest have been the beneficiaries of the increased capital flow to real estate. Prior to 2005, there was significant cap-rate compression on the coasts with only modest movement in the Central and Southern regions. Many investors have been priced out of the coasts, and they are now actively pursuing assets in the rest of the country as they see recovering fundamentals in markets such as Atlanta, Austin, Dallas, Denver, Houston and Phoenix.

In these markets, we’ve seen cap rates on office product reduced by roughly 100 to 125 basis points in the past year. As a result, there has been an abundance of product being brought to market, ranging from class A trophy assets to opportunistic buildings with occupancies in the 60%-to-80% range.

Another trend, one that started on the coasts roughly three years ago and is now occurring on a regular basis in the other markets, is a compression in holding periods. RCA stated that approximately 8% of third-quarter sales were held for less than 12 months, and more than 18% had been owned for less than 36 months. It is my belief that this trend will continue and could increase in 2006.

Development has also benefited from investors seeking higher yields than they can achieve in directly acquiring assets. With the economy in an expansion mode, tenant demand strengthening across office, industrial and retail sectors and with modest amounts of new development being delivered, market fundamentals appear to be better than they have been this decade.

As a result of these trends, developers have become very active in partnering with institutional capital to deliver new product such as industrial-distribution facilities, transportation-oriented mixed-use projects and infill development and re-development assets. Traffic patterns and congestion continue to alter the way we live, and they too provide opportunities for developers to re-energize urban areas and utilize major transit nodes to provide retail and residential properties that meet growing consumer demand.

With regard to industrial-distribution facilities, advances in technology and increased emphasis on just-in-time deliveries will weigh heavily in focusing where these facilities locate and will ultimately lead them toward regional distribution hubs, providing excellent development strategies for developers and their capital partners.

Our industry is experiencing its own version of the perfect storm given unprecedented liquidity coupled with 35- to 40-year lows in interest rates and its compressed return expectations. As stated earlier, I don’t see things changing anytime soon. Substantial increases in interest rates may eliminate some of the private leveraged buyers, but the demand for product, coupled with the flow of capital, will continue to keep real estate valued at a premium in the near term.

Steven E. Pumper is executive managing director of the investment service group of Transwestern Commercial Services in Dallas. Views expressed here are the author’s solely.