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Investor appetite strengthens for core assets

With commercial real estate fundamentals still ailing from the recession and lacking clear signs of near-term improvement, investors remain focused on core assets and proven markets, according to the third quarter 2010 findings of PricewaterhouseCoopers' Korpacz Real Estate Investor Survey®, released today.  The report highlights an improved lending environment with strong appetites from both debt and equity capital for quality real estate assets, with some surveyed investors noting a surprise at the speed at  which debt availability has rebounded over the past year.                                    

Average overall cap rates remain on downward trend 

With a limited number of quality offerings to absorb all the pent-up capital, the report reveals that competition is strong among buyers of top-rated assets, causing overall capitalization (cap) rates to remain on a downward trend.  In fact, average overall cap rates declined in 26 of the survey's 31 markets over the past three months.  Overall cap rates, the initial rate of return anticipated by a buyer and a key measure of an investor's assessment of property income and value expectations, tend to move in step with interest rates, which remain very low on a historical basis.

Surveyed investors expect overall cap rates for core assets to either flat line or decline further through the remainder of this year, as they foresee interest rates staying low and the debt markets to continue facilitating property trades.  In the near term, participants expect overall cap rates to decline in the national regional mall market (down as much as 150 basis points) and the San Francisco office market (down as much as 100 basis points).  Conversely, overall cap rates could potentially increase in the office markets of suburban Maryland and Charlotte over the next six months.

“Many investors were waiting to pounce on the anticipated overflow of underwater and distressed quality assets, but that scenario never quite materialized as expected,” said Susan Smith, director, real estate advisory practice, PricewaterhouseCoopers, and editor-in-chief of the survey.  “With the skittish economic recovery, little rent growth and minimal leasing velocity, a flight to quality is evident among investors.  Sellers offering quality commercial real estate for sale are garnering a lot of attention.”

Lodging showing market rebound

Even as the US economic recovery signals uncertainty, lodging demand is continuing to grow at a brisk pace, creating cautious optimism for this sector.  The report finds that business travelers have returned in many markets and are delivering an important short-term boost to demand.  However, the long-term demand growth is being somewhat muted by the on-going pressure on room rates. 

The Survey finds that US lodging demand is expected to increase 6.7% in 2010.  Since part of this demand growth will be absorbed by new supply, the US occupancy rate is forecast to increase only 4.7% to 57.2% in 2010 – an occupancy level 5.1 percentage points below the 20-year average of 62.3%.  Industry-wide ADR (average daily rate) is expected to recover 4.1% in 2011 and RevPAR (revenue per available room) growth is projected to be 4.1% in 2010 and 6.7% in 2011. 

Key findings and survey highlights

The report finds that the apartment sector is continuing to lead the recovery with fundamentals having bottomed in most markets, where solid improvements in occupancy and demand are being seen.

After eleven consecutive quarters of vacancy increases, the warehouse sector is finally showing signs of recovery with a downward shift in vacancy occurring in the second quarter of 2010 due to improvement in global trading, freight shipments and manufacturing activity.

As a whole, the office market continues to struggle.  Although the overall vacancy rate for the national Central Business District (CBD) office market improved slightly, job growth and feeble tenant demand remain top concerns.  Lackluster fundamentals are keeping investors and lenders focused on quality office properties and top-tier markets.

With the fragile economy continuing to hamper consumer spending, the retail sector is showing mixed reviews.  While leasing activity remains sluggish in the national mall market during the second quarter of 2010, surveyed investors note that the dynamics of the leasing market are stabilizing.

Information about subscribing to PricewaterhouseCoopers' Korpacz Real Estate Investor Survey® can be found at http://www.pwc.com/us/korpaczsurvey.

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