real estate investment quarterly highlights fourth quarter 2010
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS FOURTH QUARTER 2010 WHAT’S INSIDE
Real Estate Investment Quarterly Highlights features overviews of: nn nn nn nn nn nn
U.S. Real Estate Performance Financial Markets Apartment Markets Industrial Markets Office Markets Retail Markets
INTRODUCTION
OUTLOOK FOR REAL ESTATE INVESTMENT PERFORMANCE Positive Forces include a fourth consecutive quarter of positive NCREIF-NPI total return, the support of ongoing positive GDP growth, low investment opportunity cost with the 10-year Treasury rate holding below 4%, and improving real estate market fundamentals.
Debt financing is loosening up, both on the whole loan
and CMBS side. ACLI commercial mortgage commitments are up 25% compared with 2009. CMBS 2011 issuance is expected to total $35–$40 billion compared with $12 billion in 2010. That’s well short of the $240 billion peak in 2007, but a meaningful recovery nonetheless.
Commercial real estate total return as reported in the
NCREIF-NPI index was 4.62% for the fourth quarter of 2010 bringing the one-year total return to 13.11%. The four consecutive quarters of positive total return indicate that the rebound in commercial real estate (CRE) investment performance is solidly in place. Despite continued weak employment growth, the U.S.
economy is providing support for the turnaround in commercial real estate performance. The advance estimate for GDP growth for the fourth quarter came in at a 3.2% rate. Business-sector spending on equipment and software investment continued to be the primary driver of growth with consumer spending picking up nicely in the fourth quarter as well. Monetary policy is holding the fed funds rate at essentially
zero. The yield on the 10-year Treasury has increased from sub-3% early in the fourth quarter to ~3.70% currently based on the solidifying expectations of ongoing economic growth with easing deflation concerns. With the 10-year Treasury viewed as an “opportunity cost” against which all other investments are measured, capital flows into higher yielding investments including commercial real estate are encouraged.
2 QUARTERLY HIGHLIGHTS
Institutional interest and allocations to CRE remain strong,
as evidenced by $134 billion in commercial real estate sales in 2010, which were double that of 2009. Commercial real estate fundamentals have shown modest
improvement. Vacancy rates for apartments have declined sharply from a year ago in all major metro markets. Industrial, office and retail property vacancy rates remain elevated but inched downward in the fourth quarter. Minimal construction in the pipeline could help space markets return to equilibrium more quickly than might otherwise be expected, especially if economic growth picks up over the course of 2011 as is expected.
INTRODUCTION
Negative Forces include the ongoing adjustment in Commercial real estate debt is now more readily available property net operating incomes as leases signed at of late, though underwriting standards remain relatively the peak of the cycle expire, an unemployment rate of tight. At the same time, the overhang of distressed CRE 9+%, tepid consumer spending growth associated with debt in the portfolios of small- and medium-size banks as poor labor market conditions, fiscal and monetary policy well as in CMBS remains. Banks are slowly working through uncertainty, significant distressed commercial real estate their books via sales and restructurings. Thus far, recovery still awaiting resolution, still high vacancy rates, and a rates from sales of distressed mortgages have been quicker than expected rebound in trophy prices given significantly higher than in previous cycles. economic and real estate market conditions. Despite inching downward in recent quarters, vacancy rates are near or above historic highs for industrial (14.3%), office The relatively long structure of commercial property leases (16.4%) and retail properties (13.0%). These levels reflect means that it takes time for rent changes to feed through the severity of the recession and the ongoing malaise in job to property net operating income. On average, NOI was up creation in its aftermath. a meager 0.4% in 4Q10, but due largely to the 9% growth in apartment NOI. NOI growth was a negative 4% for industrial property and a negative 3% for office. Office and industrial Commercial property prices are up 30% from their trough properties have the potential for further declines in NOI in by some estimates, and 50% for top properties in prime coming quarters as leases mature. But, these adjustments markets. Office cap rates for Central Business District are not unexpected and should be already priced into (CBD) properties in top markets average ~6% but have property values. dipped lower for trophies. Still, economic and market conditions remain challenging and at present do not support such a rapid recovery in values. Meager job growth continues to constrain space absorption. While the economy added 385,000 net new jobs in the fourth quarter, only 900,000 of the 8.6 million jobs lost during the recession have been regained. Despite healthy growth in profits, businesses have chosen to invest in equipment and software to improve productivity rather than add to payrolls.
3 QUARTERLY HIGHLIGHTS
INTRODUCTION
CONCLUSIONS On balance, economic and capital markets conditions are supporting a new cycle upswing in U.S. commercial real estate performance. Improvement has been uneven across metro markets, property types and quality slices reflecting both disparities in real estate fundamentals as well as disparities in investor risk appetites. Near-term prospects offer more of the same with downside risks focused on possible global shocks and upside potential focused on faster U.S. employment recovery than now anticipated. Economic forecasters are weighing upside potential more heavily than downside fear. In January, 93% of the Blue Chip Economic Survey participants reported that their 2011 GDP growth forecasts will probably turn out to be too low.
Economic and Real Estate Cycles 10%
5% 2008–2Q09 Recession
0%
-5% 1990–91 Recession
-10%
2001 Recession
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 NPI Quarterly Total Returns
Real Estate Investment Quarterly Highlights: FOURTH QUARTER 2010 is prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF’s Global Real Estate Group as of December 2010. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Data is as of 12/31/2010 unless noted otherwise. Real estate investing risks include fluctuations in property values, higher expenses or lower income than expected, higher interest rates which affect leveraged investments, and potential environmental problems and liability. TIAA-CREF Asset Management is a division of Teachers Advisors, Inc., a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). TIAA-CREF® personnel in its investment management area provide investment advice and portfolio management services through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). TIAA, TIAA-CREF, Teachers Insurance and Annuity Association, TIAA-CREF Asset Management and FINANCIAL SERVICES FOR THE GREATER GOOD are registered trademarks of Teachers Insurance and Annuity Association. © 2011 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF) New York, NY 10017 C50227
4 QUARTERLY HIGHLIGHTS
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS U.S. REAL ESTATE PERFORMANCE OVERVIEW NCREIF Returns for All Property Types
Positive Total Return for All Property Types
30% (4Q rolling avgs)
NCREIF Property Index (NPI) total return for the four quarters ending December 2010 was 13.1%, vs. 5.8% for the prior four quarter period. This was the highest annual return since 2007 and fourth quarter 2010 returns were the highest since fourth quarter 2005. A 6.8% income return was the primary driver of returns, though capital appreciation was a heady 6.1% for the year. The recovery was broad based with all property types posting positive returns in the fourth quarter and four quarter period. Regionally, the East reported the highest total return for the year at 15.1% and quarter at 5.3%.
20% 10% 0% -10% -20% -30% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
4Q10
Appreciation
Pricing for All Property Types
Valuation and Transaction Cap Rates Drop Further
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5% 0% -5%
NOI 10-Yr Gr. Tsy (%) (%)
94–10 12/09 09/10
7.7 6.7 6.8
2.6 -2.9 -1.6
5.0 3.5 3.3
12/10
6.6
0.4
2.9
-10%
Cap rates implied in NPI property valuations edged down to an average of 6.63% for the four quarters ending December 2010 vs. 6.77% for the prior four quarter period. By comparison, value-weighted cap rates averaged 6.08% for the four quarter period, a 17 basis point decline from the prior period, and perhaps better reflective of current investor appetite for higher quality property. Transactional cap rates declined for the third consecutive quarter but are still some 150 basis points above their 2Q07 low.
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Cap Rate 10-Yr Treasury NOI Growth
NCREIF MSA Dispersion 20%
Positive Total Returns in Virtually All Markets
(Rolling 4 quarters ending 12/2010)
Capital Appreciation
15% 10%
Colorado Springs
U.S.
5%
Tot Ret (%)
Cap Ret (%)
0%
U.S.
13.1
6.1
-5%
Best
24.0
15.5
(Colorado Spgs)
-10%
Worst
-15%
(Cleveland)
-20% Cleveland -10%
-5%
0%
5% 10% Total Return
15%
20%
25%
-7.7 -13.9
30%
RCA Transactions
Transaction Volume Shows Big Gains Transactional volume totaled $56 billion in 4Q10, up 60% from 3Q10 and double that of 4Q09. According to Real Capital Analytics, average cap rates declined for all property types with office cap rates dropping 200 bps over the course of 2010 compared to 2 bps for apartments, 51 for industrial, and 38 for retail. Top markets like New York, Washington DC, Los Angeles, San Francisco and Boston have accounted for the majority of investment activity and seen significant price appreciation. Sales activity in secondary and tertiary markets is far weaker.
140 120
$ Billions
100 Quarterly volume through 4Q10 80 60 40 20 0
01
02
Positive total returns for the four quarter period ending December 2010 were posted in 89 out of 92 markets. Only Cleveland, Providence and Palm Bay FL failed to reach positive territory. Colorado Springs (24.0%) was the top performer for the second consecutive quarter, but major markets like Washington DC, San Diego, and New York have gravitated toward the top. Coastal markets continued to lead while the Midwest remained a laggard. Only 27 of 92 markets performed above the national average, but returns are showing considerable positive momentum.
03
04
5 QUARTERLY HIGHLIGHTS
05
06
07
08
09
10
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS FINANCIAL MARKETS OVERVIEW U.S. vs. Foreign Stocks
Emerging Market Stocks Pause, Bull Endures Elsewhere
1400 1200 1000 800 600 400 200 0 Mar Jun Sep Dec 10 10 10 10
97 98 99 00 01 02 03 04 05 06 07 08 09
ML-Developed Mkts
Russell 3000
Blmbrg-Emrg Mkts
Global stock markets continued their advance in the fourth quarter, with the U.S. Russell 3000 gaining 11%, developed non-U.S. markets gaining 2%, and emerging markets gaining 7%. During January, the pace picked up for developed non-U.S. markets which moved up another 7% while U.S. stocks rose 2%. For emerging markets, investors paused and stocks declined 3%. The effects of Egypt’s political crisis on global stock markets will take time to play out; the first large scale protest occurred January 25, leaving only four trading days before the end of January. In those four days, the price of oil reached a high of $92.19, the highest since the fall of 2008 but only marginally higher than the average posted for the month of December prior to Egypt’s eruption. Middle East political turmoil feeds through the global economy in a very visible way through oil prices.
Credit Spreads
Credit Spreads Tighten Outside Emerging Markets
2250
Investors’ appetite for credit risk cooled a bit for emerging markets in January as shown in a 20 bps rise in spreads which largely offset the spread compression that occurred in the fourth quarter. At the same time, spreads on U.S. high yield B-quality bonds narrowed steadily through January by 136 bps from their September 30 reading and BBB-quality spreads by 35 bps. Ongoing strong corporate profits growth in the U.S. is bolstering corporate balance sheets and ongoing modest GDP growth is suggesting stronger top-line revenues are ahead. It remains to be seen whether the backup in emerging market bond spreads will permeate the entire market or remain geographically isolated.
2000 1750 1500 1250 1000 750 500 250 0 97 98 99 00 01 02 03 04 05 06 07 08 09 ML B
ML BBB
ML Emerging Mkts
Mar Jun Sep Dec 10 10 10 10 Swap
*M errill Lynch Global Indices Option-Adjusted Spreads, except 10-yr Swap which is a simple spread over the 10-yr Treasury rate.
Treasury Yields Move Up Sharply
U.S. Treasury Rates 8% 7 6 5 4 3 2 1 0 97 98 99 00 01 02 2yr Trsy
5yr Trsy
6 QUARTERLY HIGHLIGHTS
03 04 05 06 10yr Trsy
07 08 09 Mar Jun Sep Dec 10 10 10 10 30yr Trsy
The Treasury yield curve shifted upward in the fourth quarter followed by a small increase in January. The 10-year Treasury yield increased 87 bps to 3.37% at the end of January with the 30-year rising 88 bps to 4.57%. Even the 2-year yield increased, albeit by only 14 bps. The updraft might seem surprising in light of another round of “quantitative easing” (QE2). The planned $600 billion in purchases of longer term Treasuries is ostensibly designed to compress yields at the longer end of the curve. Does the increase indicate that QE2 is failing? Not necessarily, in our judgment. The stronger timbre of the economy in the fourth quarter is certainly contributing to higher rates. Another contributor might be the success of the Fed in convincing the market that it is committed to dealing with an inflation rate that is too low. In other words, the Fed may be succeeding in raising inflation expectations. The first week of February brought another surge, with the 10-year rising above 3.70% for the first time since April 2010 prior to the decay in growth expectations.
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS APARTMENT MARKET OVERVIEW NCREIF Apartment Returns
Apartment Properties’ Lead Widens Total returns on apartment properties were once again the highest among the major property types at 18.2% for the four quarter period ending December 2010. The sector’s strong performance was due to a 5.9% income return and a robust 11.8% capital appreciation return. The sector’s 900 bps increase in total returns compared with the prior four quarter period was sizable vs. a 600–700 bps increase recorded by the other property types.
(4Q rolling avgs)
30% 20% 10% 0% -10% -20% -30%
4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
Appreciation
Apartment Property Pricing and Treasury
Valuation Cap Rates Inch Down Further
(4Q rolling avg, except Treasury–Qtrly avg of daily rates)
15%
Cap Rate (%)
10% 5% 0% -5% -10%
NOI 10-Yr Gr. Tsy (%) (%)
94–10 12/09 09/10
6.9 5.9 5.8
3.6 -2.9 4.8
5.0 3.5 3.3
12/10
5.8
8.8
2.9
-15% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Current Vacancy (%)
Cap Rate
NOI Growth
10-Yr Treasury
Apartment Vacancy Rate Dispersion
Apartment Vacancies Decline in Virtually All Markets
14%
The national vacancy rate declined to an average of 6.0% in 4Q10 vs. 7.4% in 4Q09, marking the fourth consecutive quarter that vacancy rates have declined. (Apartment vacancy rates are best compared on a year-over-year basis due to seasonal leasing patterns.) The improvement was broad based, with vacancies declining in 59 of the 60 markets tracked by CB Richard Ellis Economic Advisors (CBRE-EA). Apartment demand has picked up despite minimal job growth, as a shift in attitudes about homeownership has fueled growth in renter households.
12% 10%
Markets with rising vacancy U.S. 4Q10: 6.0% 4Q09: 7.4%
8% 6% 4% 2%
Markets with declining vacancy
0% 0%
2%
4%
6% 8% Vacancy Yr Ago (%)
Current Vacancy Below U.S.
10%
Current Vacancy Above U.S.
12%
14%
U.S.
Construction at Historic Lows but Developers Gear Up
Apartment Construction
Construction in 2009 and 2010 totaled some 120,000–130,000 units vs. 350,000+ during the boom, and deliveries in 2011 and 2012 will be similarly muted. Multi-family starts were running at a 100,000 unit annual pace as of December 2010 but permits issued for new units were running at a 170,000 unit pace as developers respond to the improvement in market conditions. However, sector prospects remain promising for 2011 as it will take time for construction to ramp up.
2.0% Forecast as of 3Q10 Completions/Stock
Cap rates implied in NPI apartment valuations averaged 5.76% for the four quarters ending December 2010 down from 5.84% for the prior four quarter period. Strong investor interest due to strengthening fundamentals and the availability of low cost Government Sponsored Enterprise financing are responsible. Real Capital Analytics noted that cap rate compression slowed in the fourth quarter but attributed it to sales in tertiary markets and sales of troubled properties. Sector NOI grew 8.8% for the four quarters ending December 2010, with the strong growth reflective of the pickup in demand and owners’ ability to reprice available units on a real-time basis.
1.5% 1.0% 0.5% 0.0% 95
96 97 98 99
00 01 02 03
04 05 06 07 08 09 10 11 EST. PROJ.
7 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS INDUSTRIAL MARKET OVERVIEW NCREIF Industrial Returns
Industrial Properties Continue to Lag
30% (4Q rolling avgs)
Industrial property total return was 9.4% for the four quarter period ending December 2010, the weakest of the major property types, but a sizable improvement over the 3.0% return for the prior four quarter period. Income return was a solid 7.0% for the current four quarter period, but capital appreciation’s contribution was a meager 2.0%. The sector’s subpar returns are reflective of the slower recovery in industrial market conditions as global trade flows, consumer spending and manufacturing activity gradually recover.
20% 10% 0% -10% -20% -30% 4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
Appreciation
Industrial Property Pricing and Treasury
Cap Rates Decline Despite NOI Erosion
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5%
NOI 10-Yr Gr. Tsy (%) (%)
0%
94–10 12/09 09/10
8.0 7.0 7.0
0.8 -7.9 -6.1
5.0 3.5 3.3
-5%
12/10
6.8
-3.8
2.9
-10% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Current Vacancy (%)
Cap Rate
NOI Growth
10-Yr Treasury
Industrial Vacancy Rate Dispersion
Industrial Availabilities Dip Again
30%
Industrial vacancies inched down for the second consecutive quarter to 14.3% in 4Q10 vs. 14.6% in 3Q10. While vacancies are still elevated, signs of potential improvement include positive net absorption in 4Q10 and growth in cargo shipments through key ports. Still, improvements have been very modest as vacancies remain above average in 33 of the 58 markets tracked by CBRE-EA. Nonetheless, a recovery is underway with further improvement expected first at port markets and subsequently at inland markets.
Markets with rising vacancy U.S. 25% 4Q10: 14.3% 4Q09: 14.3% 20%
15% 10% 5% 0% 0%
Markets with declining vacancy
5%
10%
Current Vacancy Below U.S.
Completions/ Stock
Implied cap rates in industrial property valuations declined to 6.76% for the four quarters ending December 2010 from 6.95% in the prior four quarter period. The dip in cap rates occurred despite a 3.8% decline in NOI growth for the four quarters ended December 2010, which was the ninth consecutive quarterly decline in sector NOI. Despite the weak property sector performance, investors are showing strong interest in industrial property as fundamentals have stabilized and cap rates appear relatively attractive compared to other property types.
15% Vacancy Yr Ago (%)
20%
25%
Current Vacancy Above U.S.
30%
U.S.
Industrial Construction
Industrial Construction at Historic Lows
3.0%
According to CBRE-EA, industrial construction totaled less than 20 msf in 2010, and is projected to average only 50 msf in 2011–2013. Construction is currently not economically feasible as new projects do not “pencil out.” Not only is it the lowest construction on record, but CBRE-EA is projecting absorption to average 200 msf over the same period. An extended lull in construction coupled with a recovery of absorption would work down the overhang of space relatively quickly.
2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
8 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS OFFICE MARKET OVERVIEW NCREIF Office Returns
Office Returns Gain Momentum
30% (4Q rolling avgs)
Office property posted an 11.7% total return for the four quarter period ending December 2010 vs. 4.6% in the prior period. Income return was 6.9% vs. 7.0% previously. Capital returns were a solid 4.6% as compared to a negative 2.3% in the prior four quarter period. While fundamentals remain challenging, stabilization in occupancies and rents along with strong investor interest in the sector have all contributed to the strong performance in the latter half of 2010.
20% 10% 0% -10% -20% -30% 4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Total Return
Income Return
Appreciation
Office Property Pricing and Treasury
Valuation and Transaction Cap Rates Drop
20% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
15% 10% 5%
94–10 12/09 09/10 12/10
0% -5% -10%
7.9 7.0 7.2 7.0
NOI 10-Yr Gr. Tsy (%) (%) 2.9 1.3 -3.9 -3.2
5.0 3.5 3.3 2.9
-15% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Cap Rate NOI Growth 10-Yr Treasury
Office Vacancy Rate Dispersion
Office Vacancy Rates Dip Again
Current Vacancy (%)
30% Markets with rising vacancy U.S. 25% 4Q10: 16.4% 4Q09: 16.3%
20% 15% 10% 5%
0% 0%
Markets with declining vacancy
5%
10%
Completions/ Stock
Current Vacancy Below U.S.
Office cap rates implied by NPI valuations fell to 6.99% for the four quarters ended December 2010 vs. 7.19% in the prior period. In the fourth quarter alone, implied valuation cap rates were even lower at an average of 6.45% vs. 6.75% previously. Transaction cap rates reported by Real Capital Analytics averaged 7.0% in 2010, but with CBD cap rates at 6.2% and suburban at 7.7%. The decline in cap rates comes at a time when NOI growth was negative for the fourth consecutive quarter at -3.2% as space leased at the market peak is released at current market rents.
15%
20%
25%
Vacancy Yr Ago (%) Current Vacancy Above U.S.
30%
Office vacancy rates fell to 16.4% in 4Q10 from 16.6% in 3Q10. While the decline is negligible, it was the second consecutive drop in the vacancy rate. The slow improvement in market conditions is evident in that vacancies rose in 28 of the 57 markets tracked by CBRE-EA and declined in the other 27. Prospects are improving, however, as professional and business services firms added 96,000 jobs in the fourth quarter; financial services firms added jobs too, albeit only 3,000. Nonetheless, market conditions are likely to improve gradually due to the lag between hiring and leasing of additional space.
U.S.
Office Construction
Office Pipeline to Drop to Historic Lows
4.0%
Office construction totaled only 20 msf in 2010 and is expected to fall below 10 msf in 2011–2012. Not only would this match the lowest construction on record, but CBRE-EA is projecting absorption to average 30 msf over the same period. Because of long project lead times, construction should remain muted well into 2013 which will allow office markets to work down the overhang of space. In prior cycles, modest employment growth coupled with minimal construction set the stage for a strong recovery in market conditions several years out.
3.0% 2.0% 1.0% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
9 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS RETAIL MARKET OVERVIEW NCREIF Retail Returns
Retail Property Holds Second Place Retail property total returns were 12.6% for the four quarter period ending December 2010 vs. 6.5% for the prior four quarter period. Income return held steady at 7.1% while capital returns jumped to 5.3% vs. a negative 0.5% previously. Sector performance has been supported by a pickup in consumer spending and retailers’ return to profitability. Though headwinds remain, consumer spending is expected to accelerate in 2011.
30% (4Q rolling avgs) 20% 10% 0% -10% -20% -30% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Total Return
Income Return
4Q10
Appreciation
Retail Property Pricing and Treasury
Retail Property Valuation Cap Rates Dip
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5%
94–10 12/09 09/10 12/10
0% -5%
8.0 6.9 7.2 7.1
NOI 10-Yr Gr. Tsy (%) (%) 2.8 -5.7 -0.4 0.9
5.0 3.5 3.3 2.9
Cap rates for retail property as implied by NPI valuations averaged 7.14% for the four quarters ending December 2010 vs. 7.16% previously. Transaction cap rates reported by Real Capital Analytics averaged 7.7% in the fourth quarter, but were closer to 7.0% for top properties. NOI growth prospects have improved as NOI grew a minimal 0.9% in the fourth quarter following eight consecutive quarters of NOI declines.
-10% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Cap Rate
NOI Growth
10-Yr Treasury
Retail Vacancy Rate Dispersion
Current Vacancy (%)
20% 16%
Vacancy rates for community and neighborhood shopping centers averaged 13.0% in the fourth quarter, same as in 3Q10 and 2Q10. While vacancies remain elevated, retail market prospects appear promising given modest job growth, growth in consumer spending, and the improvement in consumer confidence. Demand is likely to improve in the quarters ahead as retailers have completed their store closures and are cautiously opening new stores and introducing new concepts.
Markets with rising vacancy U.S. 4Q10: 13.0% 4Q09: 12.7%
12% 8% 4% 0% 0%
Markets with declining vacancy
4% Current Vacancy Below U.S.
Completions/ Stock
Retail Market Vacancies Remain Stable
8% 12% Vacancy Yr Ago (%)
16%
Current Vacancy Above U.S.
20%
U.S.
Retail Construction
Retail Construction at Historic Lows
5.0% Forecast as of 3Q10
Neighborhood and community center construction totaled a mere 5 msf in 2010, a historic low and a fraction of the 30 msf average in 2005–2008 when consumers were spending with abandon. Construction will remain muted over the next several years as well with CBRE-EA projecting an average of just 7 msf in 2011–2012 vs. absorption of 15 msf. Tight financing and retailer caution will limit construction with attention shifting to opportunities to redevelop centers in infill locations with strong surrounding demographics.
4.0% 3.0% 2.0% 1.0% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
10 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
Real Estate Investment Quarterly Highlights features overviews of: nn nn nn nn nn nn
U.S. Real Estate Performance Financial Markets Apartment Markets Industrial Markets Office Markets Retail Markets
INTRODUCTION
OUTLOOK FOR REAL ESTATE INVESTMENT PERFORMANCE Positive Forces include a fourth consecutive quarter of positive NCREIF-NPI total return, the support of ongoing positive GDP growth, low investment opportunity cost with the 10-year Treasury rate holding below 4%, and improving real estate market fundamentals.
Debt financing is loosening up, both on the whole loan
and CMBS side. ACLI commercial mortgage commitments are up 25% compared with 2009. CMBS 2011 issuance is expected to total $35–$40 billion compared with $12 billion in 2010. That’s well short of the $240 billion peak in 2007, but a meaningful recovery nonetheless.
Commercial real estate total return as reported in the
NCREIF-NPI index was 4.62% for the fourth quarter of 2010 bringing the one-year total return to 13.11%. The four consecutive quarters of positive total return indicate that the rebound in commercial real estate (CRE) investment performance is solidly in place. Despite continued weak employment growth, the U.S.
economy is providing support for the turnaround in commercial real estate performance. The advance estimate for GDP growth for the fourth quarter came in at a 3.2% rate. Business-sector spending on equipment and software investment continued to be the primary driver of growth with consumer spending picking up nicely in the fourth quarter as well. Monetary policy is holding the fed funds rate at essentially
zero. The yield on the 10-year Treasury has increased from sub-3% early in the fourth quarter to ~3.70% currently based on the solidifying expectations of ongoing economic growth with easing deflation concerns. With the 10-year Treasury viewed as an “opportunity cost” against which all other investments are measured, capital flows into higher yielding investments including commercial real estate are encouraged.
2 QUARTERLY HIGHLIGHTS
Institutional interest and allocations to CRE remain strong,
as evidenced by $134 billion in commercial real estate sales in 2010, which were double that of 2009. Commercial real estate fundamentals have shown modest
improvement. Vacancy rates for apartments have declined sharply from a year ago in all major metro markets. Industrial, office and retail property vacancy rates remain elevated but inched downward in the fourth quarter. Minimal construction in the pipeline could help space markets return to equilibrium more quickly than might otherwise be expected, especially if economic growth picks up over the course of 2011 as is expected.
INTRODUCTION
Negative Forces include the ongoing adjustment in Commercial real estate debt is now more readily available property net operating incomes as leases signed at of late, though underwriting standards remain relatively the peak of the cycle expire, an unemployment rate of tight. At the same time, the overhang of distressed CRE 9+%, tepid consumer spending growth associated with debt in the portfolios of small- and medium-size banks as poor labor market conditions, fiscal and monetary policy well as in CMBS remains. Banks are slowly working through uncertainty, significant distressed commercial real estate their books via sales and restructurings. Thus far, recovery still awaiting resolution, still high vacancy rates, and a rates from sales of distressed mortgages have been quicker than expected rebound in trophy prices given significantly higher than in previous cycles. economic and real estate market conditions. Despite inching downward in recent quarters, vacancy rates are near or above historic highs for industrial (14.3%), office The relatively long structure of commercial property leases (16.4%) and retail properties (13.0%). These levels reflect means that it takes time for rent changes to feed through the severity of the recession and the ongoing malaise in job to property net operating income. On average, NOI was up creation in its aftermath. a meager 0.4% in 4Q10, but due largely to the 9% growth in apartment NOI. NOI growth was a negative 4% for industrial property and a negative 3% for office. Office and industrial Commercial property prices are up 30% from their trough properties have the potential for further declines in NOI in by some estimates, and 50% for top properties in prime coming quarters as leases mature. But, these adjustments markets. Office cap rates for Central Business District are not unexpected and should be already priced into (CBD) properties in top markets average ~6% but have property values. dipped lower for trophies. Still, economic and market conditions remain challenging and at present do not support such a rapid recovery in values. Meager job growth continues to constrain space absorption. While the economy added 385,000 net new jobs in the fourth quarter, only 900,000 of the 8.6 million jobs lost during the recession have been regained. Despite healthy growth in profits, businesses have chosen to invest in equipment and software to improve productivity rather than add to payrolls.
3 QUARTERLY HIGHLIGHTS
INTRODUCTION
CONCLUSIONS On balance, economic and capital markets conditions are supporting a new cycle upswing in U.S. commercial real estate performance. Improvement has been uneven across metro markets, property types and quality slices reflecting both disparities in real estate fundamentals as well as disparities in investor risk appetites. Near-term prospects offer more of the same with downside risks focused on possible global shocks and upside potential focused on faster U.S. employment recovery than now anticipated. Economic forecasters are weighing upside potential more heavily than downside fear. In January, 93% of the Blue Chip Economic Survey participants reported that their 2011 GDP growth forecasts will probably turn out to be too low.
Economic and Real Estate Cycles 10%
5% 2008–2Q09 Recession
0%
-5% 1990–91 Recession
-10%
2001 Recession
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 NPI Quarterly Total Returns
Real Estate Investment Quarterly Highlights: FOURTH QUARTER 2010 is prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF’s Global Real Estate Group as of December 2010. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Data is as of 12/31/2010 unless noted otherwise. Real estate investing risks include fluctuations in property values, higher expenses or lower income than expected, higher interest rates which affect leveraged investments, and potential environmental problems and liability. TIAA-CREF Asset Management is a division of Teachers Advisors, Inc., a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). TIAA-CREF® personnel in its investment management area provide investment advice and portfolio management services through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). TIAA, TIAA-CREF, Teachers Insurance and Annuity Association, TIAA-CREF Asset Management and FINANCIAL SERVICES FOR THE GREATER GOOD are registered trademarks of Teachers Insurance and Annuity Association. © 2011 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF) New York, NY 10017 C50227
4 QUARTERLY HIGHLIGHTS
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS U.S. REAL ESTATE PERFORMANCE OVERVIEW NCREIF Returns for All Property Types
Positive Total Return for All Property Types
30% (4Q rolling avgs)
NCREIF Property Index (NPI) total return for the four quarters ending December 2010 was 13.1%, vs. 5.8% for the prior four quarter period. This was the highest annual return since 2007 and fourth quarter 2010 returns were the highest since fourth quarter 2005. A 6.8% income return was the primary driver of returns, though capital appreciation was a heady 6.1% for the year. The recovery was broad based with all property types posting positive returns in the fourth quarter and four quarter period. Regionally, the East reported the highest total return for the year at 15.1% and quarter at 5.3%.
20% 10% 0% -10% -20% -30% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
4Q10
Appreciation
Pricing for All Property Types
Valuation and Transaction Cap Rates Drop Further
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5% 0% -5%
NOI 10-Yr Gr. Tsy (%) (%)
94–10 12/09 09/10
7.7 6.7 6.8
2.6 -2.9 -1.6
5.0 3.5 3.3
12/10
6.6
0.4
2.9
-10%
Cap rates implied in NPI property valuations edged down to an average of 6.63% for the four quarters ending December 2010 vs. 6.77% for the prior four quarter period. By comparison, value-weighted cap rates averaged 6.08% for the four quarter period, a 17 basis point decline from the prior period, and perhaps better reflective of current investor appetite for higher quality property. Transactional cap rates declined for the third consecutive quarter but are still some 150 basis points above their 2Q07 low.
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Cap Rate 10-Yr Treasury NOI Growth
NCREIF MSA Dispersion 20%
Positive Total Returns in Virtually All Markets
(Rolling 4 quarters ending 12/2010)
Capital Appreciation
15% 10%
Colorado Springs
U.S.
5%
Tot Ret (%)
Cap Ret (%)
0%
U.S.
13.1
6.1
-5%
Best
24.0
15.5
(Colorado Spgs)
-10%
Worst
-15%
(Cleveland)
-20% Cleveland -10%
-5%
0%
5% 10% Total Return
15%
20%
25%
-7.7 -13.9
30%
RCA Transactions
Transaction Volume Shows Big Gains Transactional volume totaled $56 billion in 4Q10, up 60% from 3Q10 and double that of 4Q09. According to Real Capital Analytics, average cap rates declined for all property types with office cap rates dropping 200 bps over the course of 2010 compared to 2 bps for apartments, 51 for industrial, and 38 for retail. Top markets like New York, Washington DC, Los Angeles, San Francisco and Boston have accounted for the majority of investment activity and seen significant price appreciation. Sales activity in secondary and tertiary markets is far weaker.
140 120
$ Billions
100 Quarterly volume through 4Q10 80 60 40 20 0
01
02
Positive total returns for the four quarter period ending December 2010 were posted in 89 out of 92 markets. Only Cleveland, Providence and Palm Bay FL failed to reach positive territory. Colorado Springs (24.0%) was the top performer for the second consecutive quarter, but major markets like Washington DC, San Diego, and New York have gravitated toward the top. Coastal markets continued to lead while the Midwest remained a laggard. Only 27 of 92 markets performed above the national average, but returns are showing considerable positive momentum.
03
04
5 QUARTERLY HIGHLIGHTS
05
06
07
08
09
10
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS FINANCIAL MARKETS OVERVIEW U.S. vs. Foreign Stocks
Emerging Market Stocks Pause, Bull Endures Elsewhere
1400 1200 1000 800 600 400 200 0 Mar Jun Sep Dec 10 10 10 10
97 98 99 00 01 02 03 04 05 06 07 08 09
ML-Developed Mkts
Russell 3000
Blmbrg-Emrg Mkts
Global stock markets continued their advance in the fourth quarter, with the U.S. Russell 3000 gaining 11%, developed non-U.S. markets gaining 2%, and emerging markets gaining 7%. During January, the pace picked up for developed non-U.S. markets which moved up another 7% while U.S. stocks rose 2%. For emerging markets, investors paused and stocks declined 3%. The effects of Egypt’s political crisis on global stock markets will take time to play out; the first large scale protest occurred January 25, leaving only four trading days before the end of January. In those four days, the price of oil reached a high of $92.19, the highest since the fall of 2008 but only marginally higher than the average posted for the month of December prior to Egypt’s eruption. Middle East political turmoil feeds through the global economy in a very visible way through oil prices.
Credit Spreads
Credit Spreads Tighten Outside Emerging Markets
2250
Investors’ appetite for credit risk cooled a bit for emerging markets in January as shown in a 20 bps rise in spreads which largely offset the spread compression that occurred in the fourth quarter. At the same time, spreads on U.S. high yield B-quality bonds narrowed steadily through January by 136 bps from their September 30 reading and BBB-quality spreads by 35 bps. Ongoing strong corporate profits growth in the U.S. is bolstering corporate balance sheets and ongoing modest GDP growth is suggesting stronger top-line revenues are ahead. It remains to be seen whether the backup in emerging market bond spreads will permeate the entire market or remain geographically isolated.
2000 1750 1500 1250 1000 750 500 250 0 97 98 99 00 01 02 03 04 05 06 07 08 09 ML B
ML BBB
ML Emerging Mkts
Mar Jun Sep Dec 10 10 10 10 Swap
*M errill Lynch Global Indices Option-Adjusted Spreads, except 10-yr Swap which is a simple spread over the 10-yr Treasury rate.
Treasury Yields Move Up Sharply
U.S. Treasury Rates 8% 7 6 5 4 3 2 1 0 97 98 99 00 01 02 2yr Trsy
5yr Trsy
6 QUARTERLY HIGHLIGHTS
03 04 05 06 10yr Trsy
07 08 09 Mar Jun Sep Dec 10 10 10 10 30yr Trsy
The Treasury yield curve shifted upward in the fourth quarter followed by a small increase in January. The 10-year Treasury yield increased 87 bps to 3.37% at the end of January with the 30-year rising 88 bps to 4.57%. Even the 2-year yield increased, albeit by only 14 bps. The updraft might seem surprising in light of another round of “quantitative easing” (QE2). The planned $600 billion in purchases of longer term Treasuries is ostensibly designed to compress yields at the longer end of the curve. Does the increase indicate that QE2 is failing? Not necessarily, in our judgment. The stronger timbre of the economy in the fourth quarter is certainly contributing to higher rates. Another contributor might be the success of the Fed in convincing the market that it is committed to dealing with an inflation rate that is too low. In other words, the Fed may be succeeding in raising inflation expectations. The first week of February brought another surge, with the 10-year rising above 3.70% for the first time since April 2010 prior to the decay in growth expectations.
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS APARTMENT MARKET OVERVIEW NCREIF Apartment Returns
Apartment Properties’ Lead Widens Total returns on apartment properties were once again the highest among the major property types at 18.2% for the four quarter period ending December 2010. The sector’s strong performance was due to a 5.9% income return and a robust 11.8% capital appreciation return. The sector’s 900 bps increase in total returns compared with the prior four quarter period was sizable vs. a 600–700 bps increase recorded by the other property types.
(4Q rolling avgs)
30% 20% 10% 0% -10% -20% -30%
4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
Appreciation
Apartment Property Pricing and Treasury
Valuation Cap Rates Inch Down Further
(4Q rolling avg, except Treasury–Qtrly avg of daily rates)
15%
Cap Rate (%)
10% 5% 0% -5% -10%
NOI 10-Yr Gr. Tsy (%) (%)
94–10 12/09 09/10
6.9 5.9 5.8
3.6 -2.9 4.8
5.0 3.5 3.3
12/10
5.8
8.8
2.9
-15% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Current Vacancy (%)
Cap Rate
NOI Growth
10-Yr Treasury
Apartment Vacancy Rate Dispersion
Apartment Vacancies Decline in Virtually All Markets
14%
The national vacancy rate declined to an average of 6.0% in 4Q10 vs. 7.4% in 4Q09, marking the fourth consecutive quarter that vacancy rates have declined. (Apartment vacancy rates are best compared on a year-over-year basis due to seasonal leasing patterns.) The improvement was broad based, with vacancies declining in 59 of the 60 markets tracked by CB Richard Ellis Economic Advisors (CBRE-EA). Apartment demand has picked up despite minimal job growth, as a shift in attitudes about homeownership has fueled growth in renter households.
12% 10%
Markets with rising vacancy U.S. 4Q10: 6.0% 4Q09: 7.4%
8% 6% 4% 2%
Markets with declining vacancy
0% 0%
2%
4%
6% 8% Vacancy Yr Ago (%)
Current Vacancy Below U.S.
10%
Current Vacancy Above U.S.
12%
14%
U.S.
Construction at Historic Lows but Developers Gear Up
Apartment Construction
Construction in 2009 and 2010 totaled some 120,000–130,000 units vs. 350,000+ during the boom, and deliveries in 2011 and 2012 will be similarly muted. Multi-family starts were running at a 100,000 unit annual pace as of December 2010 but permits issued for new units were running at a 170,000 unit pace as developers respond to the improvement in market conditions. However, sector prospects remain promising for 2011 as it will take time for construction to ramp up.
2.0% Forecast as of 3Q10 Completions/Stock
Cap rates implied in NPI apartment valuations averaged 5.76% for the four quarters ending December 2010 down from 5.84% for the prior four quarter period. Strong investor interest due to strengthening fundamentals and the availability of low cost Government Sponsored Enterprise financing are responsible. Real Capital Analytics noted that cap rate compression slowed in the fourth quarter but attributed it to sales in tertiary markets and sales of troubled properties. Sector NOI grew 8.8% for the four quarters ending December 2010, with the strong growth reflective of the pickup in demand and owners’ ability to reprice available units on a real-time basis.
1.5% 1.0% 0.5% 0.0% 95
96 97 98 99
00 01 02 03
04 05 06 07 08 09 10 11 EST. PROJ.
7 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS INDUSTRIAL MARKET OVERVIEW NCREIF Industrial Returns
Industrial Properties Continue to Lag
30% (4Q rolling avgs)
Industrial property total return was 9.4% for the four quarter period ending December 2010, the weakest of the major property types, but a sizable improvement over the 3.0% return for the prior four quarter period. Income return was a solid 7.0% for the current four quarter period, but capital appreciation’s contribution was a meager 2.0%. The sector’s subpar returns are reflective of the slower recovery in industrial market conditions as global trade flows, consumer spending and manufacturing activity gradually recover.
20% 10% 0% -10% -20% -30% 4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total Return
Income Return
Appreciation
Industrial Property Pricing and Treasury
Cap Rates Decline Despite NOI Erosion
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5%
NOI 10-Yr Gr. Tsy (%) (%)
0%
94–10 12/09 09/10
8.0 7.0 7.0
0.8 -7.9 -6.1
5.0 3.5 3.3
-5%
12/10
6.8
-3.8
2.9
-10% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Current Vacancy (%)
Cap Rate
NOI Growth
10-Yr Treasury
Industrial Vacancy Rate Dispersion
Industrial Availabilities Dip Again
30%
Industrial vacancies inched down for the second consecutive quarter to 14.3% in 4Q10 vs. 14.6% in 3Q10. While vacancies are still elevated, signs of potential improvement include positive net absorption in 4Q10 and growth in cargo shipments through key ports. Still, improvements have been very modest as vacancies remain above average in 33 of the 58 markets tracked by CBRE-EA. Nonetheless, a recovery is underway with further improvement expected first at port markets and subsequently at inland markets.
Markets with rising vacancy U.S. 25% 4Q10: 14.3% 4Q09: 14.3% 20%
15% 10% 5% 0% 0%
Markets with declining vacancy
5%
10%
Current Vacancy Below U.S.
Completions/ Stock
Implied cap rates in industrial property valuations declined to 6.76% for the four quarters ending December 2010 from 6.95% in the prior four quarter period. The dip in cap rates occurred despite a 3.8% decline in NOI growth for the four quarters ended December 2010, which was the ninth consecutive quarterly decline in sector NOI. Despite the weak property sector performance, investors are showing strong interest in industrial property as fundamentals have stabilized and cap rates appear relatively attractive compared to other property types.
15% Vacancy Yr Ago (%)
20%
25%
Current Vacancy Above U.S.
30%
U.S.
Industrial Construction
Industrial Construction at Historic Lows
3.0%
According to CBRE-EA, industrial construction totaled less than 20 msf in 2010, and is projected to average only 50 msf in 2011–2013. Construction is currently not economically feasible as new projects do not “pencil out.” Not only is it the lowest construction on record, but CBRE-EA is projecting absorption to average 200 msf over the same period. An extended lull in construction coupled with a recovery of absorption would work down the overhang of space relatively quickly.
2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
8 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS OFFICE MARKET OVERVIEW NCREIF Office Returns
Office Returns Gain Momentum
30% (4Q rolling avgs)
Office property posted an 11.7% total return for the four quarter period ending December 2010 vs. 4.6% in the prior period. Income return was 6.9% vs. 7.0% previously. Capital returns were a solid 4.6% as compared to a negative 2.3% in the prior four quarter period. While fundamentals remain challenging, stabilization in occupancies and rents along with strong investor interest in the sector have all contributed to the strong performance in the latter half of 2010.
20% 10% 0% -10% -20% -30% 4Q10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Total Return
Income Return
Appreciation
Office Property Pricing and Treasury
Valuation and Transaction Cap Rates Drop
20% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
15% 10% 5%
94–10 12/09 09/10 12/10
0% -5% -10%
7.9 7.0 7.2 7.0
NOI 10-Yr Gr. Tsy (%) (%) 2.9 1.3 -3.9 -3.2
5.0 3.5 3.3 2.9
-15% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Cap Rate NOI Growth 10-Yr Treasury
Office Vacancy Rate Dispersion
Office Vacancy Rates Dip Again
Current Vacancy (%)
30% Markets with rising vacancy U.S. 25% 4Q10: 16.4% 4Q09: 16.3%
20% 15% 10% 5%
0% 0%
Markets with declining vacancy
5%
10%
Completions/ Stock
Current Vacancy Below U.S.
Office cap rates implied by NPI valuations fell to 6.99% for the four quarters ended December 2010 vs. 7.19% in the prior period. In the fourth quarter alone, implied valuation cap rates were even lower at an average of 6.45% vs. 6.75% previously. Transaction cap rates reported by Real Capital Analytics averaged 7.0% in 2010, but with CBD cap rates at 6.2% and suburban at 7.7%. The decline in cap rates comes at a time when NOI growth was negative for the fourth consecutive quarter at -3.2% as space leased at the market peak is released at current market rents.
15%
20%
25%
Vacancy Yr Ago (%) Current Vacancy Above U.S.
30%
Office vacancy rates fell to 16.4% in 4Q10 from 16.6% in 3Q10. While the decline is negligible, it was the second consecutive drop in the vacancy rate. The slow improvement in market conditions is evident in that vacancies rose in 28 of the 57 markets tracked by CBRE-EA and declined in the other 27. Prospects are improving, however, as professional and business services firms added 96,000 jobs in the fourth quarter; financial services firms added jobs too, albeit only 3,000. Nonetheless, market conditions are likely to improve gradually due to the lag between hiring and leasing of additional space.
U.S.
Office Construction
Office Pipeline to Drop to Historic Lows
4.0%
Office construction totaled only 20 msf in 2010 and is expected to fall below 10 msf in 2011–2012. Not only would this match the lowest construction on record, but CBRE-EA is projecting absorption to average 30 msf over the same period. Because of long project lead times, construction should remain muted well into 2013 which will allow office markets to work down the overhang of space. In prior cycles, modest employment growth coupled with minimal construction set the stage for a strong recovery in market conditions several years out.
3.0% 2.0% 1.0% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
9 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
REAL ESTATE INVESTMENT QUARTERLY HIGHLIGHTS RETAIL MARKET OVERVIEW NCREIF Retail Returns
Retail Property Holds Second Place Retail property total returns were 12.6% for the four quarter period ending December 2010 vs. 6.5% for the prior four quarter period. Income return held steady at 7.1% while capital returns jumped to 5.3% vs. a negative 0.5% previously. Sector performance has been supported by a pickup in consumer spending and retailers’ return to profitability. Though headwinds remain, consumer spending is expected to accelerate in 2011.
30% (4Q rolling avgs) 20% 10% 0% -10% -20% -30% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Total Return
Income Return
4Q10
Appreciation
Retail Property Pricing and Treasury
Retail Property Valuation Cap Rates Dip
15% (4Q rolling avg, except Treasury–Qtrly avg of daily rates)
Cap Rate (%)
10% 5%
94–10 12/09 09/10 12/10
0% -5%
8.0 6.9 7.2 7.1
NOI 10-Yr Gr. Tsy (%) (%) 2.8 -5.7 -0.4 0.9
5.0 3.5 3.3 2.9
Cap rates for retail property as implied by NPI valuations averaged 7.14% for the four quarters ending December 2010 vs. 7.16% previously. Transaction cap rates reported by Real Capital Analytics averaged 7.7% in the fourth quarter, but were closer to 7.0% for top properties. NOI growth prospects have improved as NOI grew a minimal 0.9% in the fourth quarter following eight consecutive quarters of NOI declines.
-10% 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Cap Rate
NOI Growth
10-Yr Treasury
Retail Vacancy Rate Dispersion
Current Vacancy (%)
20% 16%
Vacancy rates for community and neighborhood shopping centers averaged 13.0% in the fourth quarter, same as in 3Q10 and 2Q10. While vacancies remain elevated, retail market prospects appear promising given modest job growth, growth in consumer spending, and the improvement in consumer confidence. Demand is likely to improve in the quarters ahead as retailers have completed their store closures and are cautiously opening new stores and introducing new concepts.
Markets with rising vacancy U.S. 4Q10: 13.0% 4Q09: 12.7%
12% 8% 4% 0% 0%
Markets with declining vacancy
4% Current Vacancy Below U.S.
Completions/ Stock
Retail Market Vacancies Remain Stable
8% 12% Vacancy Yr Ago (%)
16%
Current Vacancy Above U.S.
20%
U.S.
Retail Construction
Retail Construction at Historic Lows
5.0% Forecast as of 3Q10
Neighborhood and community center construction totaled a mere 5 msf in 2010, a historic low and a fraction of the 30 msf average in 2005–2008 when consumers were spending with abandon. Construction will remain muted over the next several years as well with CBRE-EA projecting an average of just 7 msf in 2011–2012 vs. absorption of 15 msf. Tight financing and retailer caution will limit construction with attention shifting to opportunities to redevelop centers in infill locations with strong surrounding demographics.
4.0% 3.0% 2.0% 1.0% 0.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 EST. PROJ.
10 QUARTERLY HIGHLIGHTS
Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research
