Wednesday
October 22, 2014

Year of the 'Small Deal'

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Year of the 'Small Deal'

Medium-sized markets are poised to shine in 2013 with investors eyeing industrial opportunities.

Last year was a sizzler for commercial real estate. “In 2012, markets expanded much faster and stronger than many anticipated,” says Ken Riggs, CRE, CEO of Real Estate Research Corp. in Chicago. Deal volume for sales over $2.5 million reached almost $268.5 billion, a 17 percent increase over 2011, according to preliminary estimates from Real Capital Analytics. Capital markets, especially CMBS, also surged, with bond sales reaching $46 billion in 2012, a 50 percent gain over 2011, according to JP Morgan Chase & Co.

So, will 2013 be as robust? “It’s going to be a hot year for real estate,” predicts Mitch Roschelle, U.S. real estate advisory practice leader for PwC in New York. Investors looking for durable cash flow will still choose commercial real estate, he says. Roschelle believes that 2013 will be “the year of the small deal.” All the publicity is about the $100 million–plus sales, but “this year will see small partnerships pooling capital to buy commercial real estate,” he says.

CMBS lending is also beginning to look favorably on smaller deals in secondary markets. Case in point: In Dec. 2012, Bob Goldstein, CEO of Hospitality Consultants in Boca Raton, Fla., closed a $3.95 million, 81-unit hotel deal for a client that had a $2.3 million nonrecourse loan from a major national bank. The bank planned to securitize the mortgage through a CMBS pool. “In 2013, we expect to see a continued, gradual decrease in vacancy and a modest improvement in rents for most property types, in most markets,” says Fred Schmidt, president and COO of Coldwell Banker Commercial. He cites a few national stats comparing results from the third quarter of 2012 with projections for 2013 performance. The trends cited below are generally consistent with forecasts for the same sectors by NAR’s research department.

  • Multifamily vacancy will drop to 4.3 percent by late 2013, from 4.6 percent in the third quarter of 2012, according to REIS.
  • Industrial vacancy will decline to 11.8 percent from 12.4 percent, per CoStar.
  • Office vacancy will drop to 16.5 percent from 17.1 percent, per REIS.
  • Retail remains unchanged at 10.8 percent, per REIS, with fortress malls and grocery-anchored strips performing best.

Secondary Cities Heat Up

Building on a trend from last year, 2013 also promises to be the year of the smaller city. Some of the top investment choices from respondents to the respected Emerging Trends in Real Estate 2013 survey were perennial favorites such as Seattle, Denver, and Austin, Texas. Other less-expected picks from the survey of brokers, developers, and other industry experts conducted by PwC and the Urban Land Institute include Charlotte, N.C., and Miami, both of which have recovered after losing jobs during the recession. These two cities, along with Salt Lake City, which has become a corporate favorite because of its low average wage and well-educated population, posted the largest year-over-year gains in survey rankings.

In Miami, the engine is international trade. “There's an institutional feeding frenzy for larger warehouses that has pushed prices beyond ’06 peaks,” says Steven Medwin, CCIM, SIOR, managing director with Jones Lang LaSalle in Miami. Leasing activity is up 60 percent from 2009, and more than 10 spec warehouses have been announced, he says. Growing demand for consumer goods in Latin America and a hope to lock in warehouse space before the first container ships pass through the wider Panama Canal in late 2014 are big reasons for the surge.

Even markets that are well below most investors’ radar, like St. Louis and Minneapolis, are starting to get attention, says Jon Southard, managing director of global research and consulting with CBRE Econometric Advisors in Boston. “If you can squeeze out a 6 or 7 percent yield in a city like Minneapolis, that looks good to investors on a risk-adjusted basis,” agrees Dan Fasulo, managing director with Real Capital Analytics in New York. Investing in secondary markets is split between institutional and local buyers, says Riggs. Private buyers such as local businesses and wealthy individuals still dominate smaller markets, and “those investors usually know the market and behave rationally,” he says.

Institutional buyers in smaller markets are picking individual assets with long-term income in place. “They aren’t buying the market as a whole; they are buying the credit of the tenant,” says Fasulo.

Multifamily Cools, A Little

Although apartments remain the most favored investment, “some investors are beginning to question the lower cap rates for multifamily in some secondary markets, says Fasulo. According to Real Capital Analytics, vacancies for multifamily were 6.1 percent nationally, but below 5 percent in hot markets. “The party isn’t over, but most of the Emerging Trends respondents expect that new multifamily construction will start to meet demand by the end of 2013,” says Roschelle.

Still, many brokers like Andy Burnett, CCIM, of Sperry Van Ness in Oklahoma City are finding that “multifamily is definitely still in vogue with investors.” Fueled by shale oil profits and a strong biotech sector, Oklahoma City has a 92 percent multifamily occupancy, 96 percent in Class A properties.

Some pension funds are still bullish enough on apartments to zero in on a few hot markets like San Francisco and Orange County, Calif., says Michael Miyagishima, CCIM, managing director with Sperry Van Ness MCRE Inc. in San Francisco. “On new apartment developments, the institutions expect a 13 to 17 percent return, compared to cap rates below 4 percent on existing Class A apartments in core areas,” 
he says. Other top apartment markets in terms of rent growth include Portland, Ore., and Minneapolis, according to Marcus & Millichap’s research.

The Next Hot Thing?

“Industrial is poised to be the next apartments, in terms of investor allocation and tenant demand,” says Jim Carpenter, executive director of capital markets for Cushman & Wakefield. Nationwide, industrial properties saw a 7 percent increase in investment volume during 2012. The biggest drivers for future growth: renewed consumer confidence and the growing need for shipping by e-commerce retailers.

Offshore investors are also moving into the sector through investments in private equity firms. Foreign buyers are snapping up properties in top-performing markets like Los Angeles, New Jersey, and Houston, Carpenter says. Secondary markets that could show strength this year include Indianapolis, Phoenix, and Memphis, Tenn.

Not everyone is bullish on industrial. “Larger, new properties near ports and transportation hubs will continue to do well,” says CBRE’s Southard, “but that’s a small part of the market.”

In the end, taking advantage of hot markets is about timing and studying the cycle, Southard says. Investors must capture the moment when low vacancies and a lack of new construction generate above-average rent growth. His pick for the next hot property: Class A suburban offices. “The trend to move back downtown has been exaggerated and prices on suburban office are good in many markets,” he says.

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