Equity Investors Have Plenty of Capital

According to the latest PricewaterhouseCoopers Korpacz Real Estate Investor Survey, equity funds in the market this year are slated to raise more than $318 billion, which would be up 35% from the amount targeted by the funds in the market all of last year, the report noted, citing data from Real Capital Analytics.

“It’s hard to see all of this capital because it is not moving,” concluded the survey of REITs, pension funds, mortgage bankers, developers, insurers and other institutional investors and property managers.

Sales since last year’s third quarter have been paralyzed by a lack of debt financing caused by credit markets dislocation and by uncertainty over how far lower property prices will move. The survey said that investment capital remains on the sidelines “waiting for signs that the worst is over.”

It also noted that capital is growing increasingly concerned about how much a stalled economy may impact property fundamentals.

The $46.5 billion of commercial property sales, including hotels, closed in Q1 was down about 66% from more than $135 billion in the same period a year ago, the report noted, again citing Real Capital Analytics. Moreover, less than 50 investors have spent more than $100 million in Q1. That’s down from 150 that spent $100 million or more on commercial property in the year-ago period.

Much of the capital waiting on the sidelines is from foreign buyers, who began exhibiting increased interest in U.S. property last year when they accounted for more than $50 billion in investments here, more than double their 2006 amount.

The Korpacz report also said that pension funds by and large over the past year have increased their allocation targets for real estate, but noted that many of those funds may divert a large portion of those increased allocations to foreign property markets.

Office market investors seem the most confident that pricing is already turning more in favor of buyers. “While pricing may still be tricky to figure out, it appears that this market is shifting in favor of buyers,” said an office investor respondent.

The survey estimates that the average capitalization rate for central business district office properties rose 5 basis points between the fourth and first quarters to 6.68%, while the average for suburban office rose 15 bp to 7.28%.

The warehouse sector’s average cap rate rose 9 bp to 6.56, while in the retail sector, the average for shopping centers rose 4 bp to 7.32%, for malls it rose 3 bp to 6.71% and for power centers it rose 4 bp to 7.17%.

The multifamily sector’s average dropped 4 bp to 5.75, the only sector capitalization rate decline in the survey. The survey noted that multifamily sector investing has been buoyed by debt financing from Freddie Mac and Fannie Mae, which is “helping prices remain elevated.”

Meanwhile, investors are getting skittish about the economy and how that might impact property fundamentals, which had been strong through much of the credit-markets islocation. “Fundamentals have held up relatively well, but we are starting to see rental growth decline and vacancy rates inch up, which ultimately reduces value,” said another respondent to survey.

Job losses, one of the most obvious symptoms of a slowed economy, pose an immediate threat to demand for multifamily property, whose national vacancy rate grew 20 bp to 5.9% in Q1.

The report noted that multifamily is grappling with over-supply that’s exacerbated by a shadow market of condominium units being added to the rental inventories in some markets.

The Korpacz survey’s concern about the shadow market hurting multifamily fundamentals was cited earlier this by research firm Reis Inc. that noted Miami’s rental market added 1,300 condo units in the first quarter and will add another 8,500 by the end of the year.

A slowing economy may already be impacting warehouse property fundamentals, as the Korpacz report noted that the segment’s average initial-year market rent in the first quarter grew 2.94%, down 29 bp from the previous quarter’s growth rate and the sector’s first such quarterly decline in growth rate since Q4 2005.

As a result, survey respondents predicted that warehouse properties would appreciate an average of 50 bp this year, down from a 2.71% average appreciation predicted in the Korpacz survey a year ago. Some said warehouse values could depreciate up to 10% this year.

On the retail property side, one survey respondent lamented, “As consumers spend less money on retail goods, landlords will have a harder time pushing up rental rates and collecting percentage rent.”

The 2.4% of growth in same store sales during 2007 was the sector’s lowest annual growth in more than 20 years, according to Bank of Tokyo Mitsubishi. The Korpacz survey also reported that while slower sales have forced many retailers to declare bankruptcy or close some stores over the past year, concern is growing that still more will shelve expansion plans in the near-term.

Recently-built and under-construction malls will have trouble reaching strong occupancy levels, while many power centers face declining rents, the Korpacz report predicted. It added that a suspected softening in fundamentals will further weaken investor demand for class-B malls, while class-A malls remain in demand but rarely come to market.

Retail strip centers have suffered one of the largest property sector sales declines, with $3.3 billion in Q1 sales down 77% from the year ago-period. But, the Korpacz report says investor demand for these properties is keen in population growth markets such as Atlanta, where 104 strip centers were sold in Q1. That’s about 2.3% of the total nationwide.

Office property fundamentals remain strong with a 9.9% national vacancy rate and 17.5 million sf of leasing activity in the first quarter, both comparable to levels reported in the same period a year ago, according to Cushman & Wakefield.

But, the Korpacz survey cited widespread concern that an ongoing economic slowdown will seriously cripple office fundamentals and investor demand in suburban and tertiary markets. The concern is particularly acute in markets that have had extensive construction, such as Phoenix, where 1.1 million sf of speculative office space was added in Q1.

Office investors are also concerned that the sector has not yet realized the full impact of the economic slowdown because it tends to lag the economy’s performance. One office investor remarked, “While we do not see losses in occupancy, I do think they are coming.”