The commercial real estate market is increasingly dominated by institutional investors who require periodic performance measures of their investment portfolios. This presents a challenge to private real estate investments because individual properties are not bought and sold on a regular basis like stocks and bonds. Therefore, investors cannot measure gains or losses in their real estate portfolio based on actual transaction prices. They must use alternative measures of real estate performance.
This article will provide an overview on how performance measures for real estate investments are constructed and used by institutional investors. In particular, the article will focus on an index of real estate performance published by the National Council of Real Estate Investment Fiduciaries (NCREIF). The index includes over 1,500 properties whose market value in 1995 exceeds $20 billion dollars of commercial real estate.(l) This article will show how the index is used both to gauge the performance of real estate compared to other asset classes and to measure the performance of different property types and geographic areas so institutional investors can make diversification decisions. Understanding these indices helps real estate professionals understand the motivations of institutional investors when purchasing, valuing and selling real estate income property. These indices can also be used to track trends in real estate values and capitalization rates for different property types and geographic areas.
Construction Of Performance Measures
Indices of real estate performance measure change in the rate of return over time, e.g., annual or quarterly rates of return. As indicated earlier, this is easy for publicly traded investments like stocks and bonds because transaction prices are available to measure changes in value. In the case of real estate, it is necessary to rely on appraised values as a proxy for transaction prices. Institutional investors which hold property for pension funds are required to mark to market, i.e., report the market value of their holdings. Thus, appraisals are done on a periodic basis, usually once per year by an outside appraiser with quarterly updates by inside appraisers.
Performance measures essentially calculate an internal rate of return (IRR) for each time period, e.g., each year, based on the appraised value of the property at the beginning and end of the period as well as the net operating income (NOI) received during the period. This is shown in the following equation:
Equation 1
Total Return = NOI + (Sale price - Purchase price)/ Purchase Price (1)
Equation 1 calculates an internal rate of return for a single period of time. The return is called the total return because it includes return from net operating income and change in value (sale price -purchase price). This return assumes that the property could be sold each year at its appraised value.(2) In the case of stocks and bonds, dividend and interest income respectively would be used in place of NOI and actual transaction prices would be used for the sale price and purchase price.
Income And Capital Return
The total return already discussed can be broken down into an income return and a capital return. The income return is equal to
Income Return = NOI / Purchase Price (2)
The income return is analogous to an overall capitalization rate (cap rate) for a property. There may be differences, however, because the NOI used by the institutional investor may differ from the NOI used by an appraiser. For example, the institutional investor may not include any replacement allowance in the operating expenses which, compared to what the appraiser might estimate, may tend to understate the NOI. Alternatively, the institutional investor might include expenses for remodeling, leasing commissions, tenant improvements, etc. which, compared to what an appraiser would use as a stabilized expense, would overstate expenses.
Aside from these differences, trends in the income return can provide valuable insight into trends for capitalization rates. Thus, performance measures can provide a valuable complement to other sources of capitalization rates used by appraisers and counselors.
The capital return measures the effect of any appreciation or depreciation on the rate of return. It is calculated as follows: Capital Return = (Sale price - Purchase price) / Purchase Price (3)
The capital return assumes gain or loss which is recognized each period, e.g. the property is sold and repurchased. The capital return is also referred to as the appreciation return. It is possible, of course, that the appreciation be negative, i.e., depreciation in capital value.
Index
An index is often calculated from the return measures. The index indicates how much wealth the investor would have accumulated if he invested in the property and held it over time. It reflects cumulative rates of return over time. For example, if the total return was 5 percent in year 1 and 6 percent in year 2, n, an investment of $100 would increase to ($100 x 1.05 x 1.06) or $111.30 by the the end of the second year.
Example
Exhibit I is an example of the calculation on the income return, appreciation return and total return. The table also indicates how an index could then be calculated with 100 as the starting point.
Exhibit II illustrates the returns for the example in the graph. Note that the income return is relatively constant when capitalization rates do not vary significantly over time. Most of the variability is in the appreciation return. The average total return is 8.91 percent and the standard deviation of the total return is 3.51 percent.(3)
NCREIF Property Index
Institutional investors who are members of NCREIF report the information necessary to calculate income and capital returns on properties they hold. The formula used by NCREIF is a slight variation of the formula already discussed that includes the impact of any capital improvements and partial sales on the return. The differences are not material and do not affect the interpretation of the index.(4)
The NCREIF index is calculated by averaging the returns for all the individual properties reported to the organization by its members. The average can either be equal weighted or value weighted. Value weighting places more weight on the return from properties that have greater appraised values. This is the manner in which the traditional NCREIF Index is calculated. Exhibit III shows the total returns over time based on both equal and value weighted returns.(5)
Exhibit IV shows a breakdown if quarterly income and appreciation returns for the NCREIF Index. Note that income returns (cap rates) have been relatively steady over time and most of the volatility has been in the capital (appreciation) return. Because the returns are quarterly, they have to be multiplied by 4 for an estimate of the annual return.
Performance Of Different Property Types
NCREIF also reports performance measures for the different property types held by its members. Exhibit V shows a breakdown of quarterly returns by property type. Note that the relative performance of different property types varies over time. This is important because it indicates that institutional investors can receive diversification benefits by including different types of properties in a portfolio.
Performance Measures For Different Geographic Regions
NCREIF also breaks down performance measures by geographic regions. Exhibit VI shows the results. Again, note that performance differs over time for different regions which suggests diversification benefits for holding properties in different regions of the country.
Indices For Different Metropolitan AreasOffice Buildings
It is also possible to request performance measures from NCREIF for different metropolitan areas where a sufficient number of properties are held by its members. This provides a more refined analysis on the performance of different property types and trends by metropolitan area for different property types. More sophisticated institutional investors make diversification decisions by evaluating returns for different metropolitan areas. Exhibit VII shows the performance of office buildings in different metropolitan areas.(6)
Performance Of Private And Public Markets
With the tremendous growth of the REIT industry in recent years, public markets have become an alternative vehicle for institutional investors to hold real estate rather than make investments in the private market. As discussed, the NCREIF Index is based on appraised values of individual properties held directly by institutional investors. Performance measures also exist for REITs such as the NAREIT and Wilshire Indices. An important issue to consider is whether we can directly compare the performance of public and private market indices.
Two problems have been identified in making these comparisons. First, public market indices have much more volatility. Perhaps this is because they are based on actual transaction prices rather than appraised values. Another explanation is that trading by Wall Street introduces more volatility because REITs behave more like stocks, and thus are subject to the whims of the market. In either case, the differences in volatility must be considered. Second, transaction prices in public markets seem to lead appraised values in private markets. This may occur because public markets are better at anticipating and are quicker to reflect changes in market conditions. It may also be because the appraiser is less likely to put as much weight on the most recent transaction when estimating market value. We know that transaction prices for individual properties may not be indicative of market value. Furthermore, comparable sales are, by nature, historical despite attempts to make adjustments in market conditions.
To better understand the difference in performance of public and private markets, Exhibit VIII compares the NCREIF and NAREIT Indices. The differences are handled by 1. using different scales for the performance of the NCREIF versus the NAREIT Index to adjust for differences in volatility, and 2. lagging the return for the NAREIT Index by one year since it tends to lead the NCREIF Index. The performance over the period shown in the graph, 1978 to 1992, is quite informative. Note that the NAREIT Index rises relative to the NCREIF Index in 1991. This is the result of the 1981 tax act which increased the tax benefits to private market investors and produced a repricing of real estate. The returns in the exhibit are before tax. Thus, lower before tax returns were needed on private market investments relative to public market investments after 1981. These tax benefits were essentially eliminated in 1986, and we see the NAREIT Index decreasing as we move into 1986. This is followed by a significant decline in the NAREIT Index during the late 1980s as public markets appear to anticipate the real estate recession much faster than private markets. The NCREIF Index was slow to respond to declining real estate prices and the effect this had on performance. The opposite may have occurred in the early 1990s when public markets anticipated a recovery and prices rose for REITs faster than appraised values used for the NCREIF Index. The author expects these two markets will get closer in the future as institutional investors move funds between these markets and attempt to take advantage of any perceived arbitrage opportunities.
Conclusion
Indices of real estate performance can provide valuable insights into trends in real estate values and cap rates for different property types in different geographic areas. Although indices for private real estate markets are difficult to compare with their public market counterparts based on stocks (including REITs) and bonds, trends in the performance of REITs can provide insight to trends in private market performance. Real estate counselors and other industry professionals can use these performance measures to supplement more traditional sources of cap rate and return information for commercial real estate.
NOTES
1. Information about the index can be obtained by contacting NCREIF at Two Prudential Plaza, 180 N. Stetson Avenue, Suite 2515, Chicago, IL 60601. Telephone (312) 819-5890.
2. Although this seems quite reasonable, there have been several studies that suggest appraised values lag changes in transaction prices. See for example "On the Reliability of Commercial Ap praisals: An Analysis of Properties Sold from the RussellNCREIF Index (1978-1992)", R. Brian Webb, Real Estate Finance, Spring, 1994.
3. The standard deviation is a measure of the variability of the cash flows as defined in any standard statistics book. It is often used as a measure of the riskiness of an investment's returns.
4. For further discussion see Giliberto, S.F. "The Inside Story on
Rates of Return," Real Estate Finance, Spring 1994.
5. The equal weighted returns were calculated by the author with permission of NCREIF and first appeared in Fisher, Jeffrey D. "Alternative Measures of Real Estate Performance: Exploring the Russell-NCREIF Data Base," Real Estate Finance, Fall 1994.
6. This exhibit first appeared in Real Estate Portfolio Management and Strategy," a seminar prepared by Jeffrey D. Fisher and sponsored by the National Council of Real Estate Investment Fiduciaries (NCREIF) in Chicago, August 1994. The reader should note that metropolitan indices are based on relatively small sample sizes and may not always be representative of returns for the entire metropolitan area.
Jeffrey D. Fisher, Ph.D. is director of the Center for Real Estate Studies and associate professor of finance and real estate at the Indiana University School of Business. Currently he serves on the Board of Directors of the National Council of Real Estate Investment Fiduciaries (NCREIF).
Monday, December 31, 2007
Saturday, December 29, 2007
AMREP Announces New Direction for Its Rio Rancho, New Mexico Real Estate Business
NEW YORK--(BUSINESS WIRE)--March 23, 1999--AMREP Corporation (NYSE:AXR) today announced that the future direction of its Rio Rancho, New Mexico real estate business will be the development and sale of land for residential, commercial and industrial uses rather than the construction and sale of housing. The Company is currently involved in both of these businesses. As part of this new direction, the Company expects to sell developed and undeveloped residential lots to a variety of national, regional and local homebuilders and to close its Rio Rancho home construction operation once this division has fulfilled its current obligations.
For the last two decades, AMREP Southwest, Inc., a Company subsidiary, has been the major developer of and homebuilder in Rio Rancho, New Mexico, the incorporated portion of which is now the fourth largest city in New Mexico with a population exceeding 50,000. Numerous national and regional companies have a significant presence in Rio Rancho, including Intel, NationsBank and Victoria's Secret. AMREP Southwest is still the largest landowner in Rio Rancho, with holdings which include several thousand acres in contiguous blocks suitable for development.
"We now see AMREP Southwest's best opportunities at Rio Rancho to be as a developer of residential, commercial and industrial land for use by others," said Jim Wall, President and Chief Executive Officer of AMREP Southwest. "We believe that attracting a number of different homebuilders to Rio Rancho will add diversity to the new homes being built and make Rio Rancho an even more desirable place to live, which should accelerate the development and sale of the substantial acreage we own there. As this development proceeds, we will continue to work closely with the local government and play a major role in community affairs."
On January 27, 1999, the Company announced that AMREP Southwest had entered into an agreement with Centex Homes, a subsidiary of one of the country's largest homebuilders, for the potential sale to Centex of more than 1,000 lots in the Enchanted Hills subdivision of Rio Rancho, and since then AMREP Southwest has also entered into separate arrangements with homebuilders for the sale of up to 200 other lots in Rio Rancho. Today, the Company announced that AMREP Southwest has signed a contract with a subsidiary of D.R. Horton, another well-known national homebuilder, under which the Horton subsidiary is expected to buy approximately 400 lots in the Northern Meadows subdivision of Rio Rancho this year, with plans for up to 175 additional lots late next year. If all of these transactions (many of which are in the nature of options) close as now scheduled, AMREP Southwest would sell approximately 1,800 lots to builders between January 1, 1999 and April 30, 2001.
AMREP Corporation Chairman of the Board, Ed Cloues commented, "For the last few months, AMREP's Board of Directors and management have been considering the best strategic direction to maximize the Company's return on its significant investment in land at Rio Rancho. By changing our emphasis from homebuilding to land sales and development, we should be able to pay down debt, build cash, simplify our business and organization in Rio Rancho and focus on one primary activity in Rio Rancho rather than two. This shift in emphasis should also lead to a more rapid and effective utilization of the Company's Rio Rancho real estate assets while at the same time reducing risk by positioning the Company so that it is better able to cope with any economic downturn that might occur. The Board and management are also actively reviewing the future direction of the Company's other real estate operations."
AMREP Corporation is a developer of real estate, primarily in New Mexico, Colorado, Northern California, and Oregon. Through its Kable News Company subsidiary, it also distributes magazines to wholesalers and provides subscription fulfillment and other services to publishers.
This news release contains forward-looking statements relating to the Company's future strategy in Rio Rancho, New Mexico that involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from those which might be indicated or suggested by such forward-looking statements include the failure of the buyers to purchase the lots covered by the existing agreements, the risk of a reduced level of demand for residential, commercial or industrial land in Rio Rancho and the possibility that future economic and business conditions will be less favorable than the Company expects. Further information about these and other relevant risks and uncertainties may be found in the Company's filings with the Securities and Exchange Commission, all of which are available from the Commission as well as from other sources. Recipients of this news release are cautioned to consider these risks and uncertainties and to not place undue reliance on the forward-looking statements contained herein.
For the last two decades, AMREP Southwest, Inc., a Company subsidiary, has been the major developer of and homebuilder in Rio Rancho, New Mexico, the incorporated portion of which is now the fourth largest city in New Mexico with a population exceeding 50,000. Numerous national and regional companies have a significant presence in Rio Rancho, including Intel, NationsBank and Victoria's Secret. AMREP Southwest is still the largest landowner in Rio Rancho, with holdings which include several thousand acres in contiguous blocks suitable for development.
"We now see AMREP Southwest's best opportunities at Rio Rancho to be as a developer of residential, commercial and industrial land for use by others," said Jim Wall, President and Chief Executive Officer of AMREP Southwest. "We believe that attracting a number of different homebuilders to Rio Rancho will add diversity to the new homes being built and make Rio Rancho an even more desirable place to live, which should accelerate the development and sale of the substantial acreage we own there. As this development proceeds, we will continue to work closely with the local government and play a major role in community affairs."
On January 27, 1999, the Company announced that AMREP Southwest had entered into an agreement with Centex Homes, a subsidiary of one of the country's largest homebuilders, for the potential sale to Centex of more than 1,000 lots in the Enchanted Hills subdivision of Rio Rancho, and since then AMREP Southwest has also entered into separate arrangements with homebuilders for the sale of up to 200 other lots in Rio Rancho. Today, the Company announced that AMREP Southwest has signed a contract with a subsidiary of D.R. Horton, another well-known national homebuilder, under which the Horton subsidiary is expected to buy approximately 400 lots in the Northern Meadows subdivision of Rio Rancho this year, with plans for up to 175 additional lots late next year. If all of these transactions (many of which are in the nature of options) close as now scheduled, AMREP Southwest would sell approximately 1,800 lots to builders between January 1, 1999 and April 30, 2001.
AMREP Corporation Chairman of the Board, Ed Cloues commented, "For the last few months, AMREP's Board of Directors and management have been considering the best strategic direction to maximize the Company's return on its significant investment in land at Rio Rancho. By changing our emphasis from homebuilding to land sales and development, we should be able to pay down debt, build cash, simplify our business and organization in Rio Rancho and focus on one primary activity in Rio Rancho rather than two. This shift in emphasis should also lead to a more rapid and effective utilization of the Company's Rio Rancho real estate assets while at the same time reducing risk by positioning the Company so that it is better able to cope with any economic downturn that might occur. The Board and management are also actively reviewing the future direction of the Company's other real estate operations."
AMREP Corporation is a developer of real estate, primarily in New Mexico, Colorado, Northern California, and Oregon. Through its Kable News Company subsidiary, it also distributes magazines to wholesalers and provides subscription fulfillment and other services to publishers.
This news release contains forward-looking statements relating to the Company's future strategy in Rio Rancho, New Mexico that involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from those which might be indicated or suggested by such forward-looking statements include the failure of the buyers to purchase the lots covered by the existing agreements, the risk of a reduced level of demand for residential, commercial or industrial land in Rio Rancho and the possibility that future economic and business conditions will be less favorable than the Company expects. Further information about these and other relevant risks and uncertainties may be found in the Company's filings with the Securities and Exchange Commission, all of which are available from the Commission as well as from other sources. Recipients of this news release are cautioned to consider these risks and uncertainties and to not place undue reliance on the forward-looking statements contained herein.
Friday, December 28, 2007
Andrew Johnson - Real Estate - Brief Article
Andrew Johnson has formed his own commercial real estate firm, Johnson Commercial Brokerage, in Los Angeles. Before this, he was a vice president with Spencer-Scott Real Estate Group.
Thursday, December 27, 2007
An International Perspective on Real Estate Research Priorities
Executive Summary. Surveys of real estate research priorities for real estate fund managers in the United States, United Kingdom, Australia and Germany over 2000-03 are examined. Thirty-nine real estate research priorities are assessed, with much closer alignment for real estate research priorities in the U.K., Germany and Australia than seen for the U.S. The role of real estate in a mixed-asset portfolio and real estate and portfolio risk management figure prominently amongst the general real estate research priorities. The top specific real estate research priorities were the impact of capital flows, real estate cycles and real estate portfolio diversification. The underlying general real estate research priorities "dimensions" highlight the strategic issues involved in real estate research, particularly the changing real estate environment, strategic real estate issues and the role of real estate in the portfolio.
Introduction
Real estate research has taken on increased importance in recent years in the international arena. The establishment of the regional real estate societies (particularly ARES, ERES, PRRES and AsRES) and their annual conferences have been key catalysts to this expanded real estate research agenda, with much of this research having a strong real estate industry focus. As such, general real estate research areas have been identified by leading real estate academics in the United States and the United Kingdom (Lusht, 1993; Webb, 1997; Jaffe, 1998; Crosby, 2000; Worzala, 2002; and Adair, Crosby, Lim and Watkins, 2003), as well as by leading U.S. and Australian real estate practitioners (Winograd, 1999; Souza, 2000; Parker, 2001; and Steinert and Crowe, 2001).
To more fully assess the real estate research directions and priorities for U.S. institutional investors, extensive real estate industry surveys have been funded by the National Council of Real Estate Investment Fiduciaries (NCREIF) in 1992 (Ziering and Worzala, 1997) and the Pension Real Estate Association (PREA) in 2000 (Worzala, Gilliland and Gordon, 2002), with Newell, Acheampong and Worzala (2002) conducting an equivalent real estate research priorities survey for Australia in 2001. In 2003, equivalent real estate research priority surveys have been conducted in the U.K. (Newell, McAllister and Worzala, 2003) and Germany (Schulte, Newell and Worzala, 2003).
Given these significant international real estate research developments, the purpose of this research is to compare the results of these four recent major international real estate surveys to examine the real estate research priorities of real estate fund managers in the U.S., U.K., Australia and Germany. Identification of these real estate research priorities will enable the more effective development of a real estate research agenda for real estate researchers in ARES, ERES, PRRES and AsRES, as well as for the emerging real estate societies of AfRES and LaRES.
Methodology
Surveys
Separate questionnaires involving general and specific real estate research topics for real estate fund managers were conducted in U.S. (Worzala et al., 2002), Australia (Newell et al., 2002), U.K. (Newell et al, 2003) and Germany (Schulte et al., 2003). From these four surveys conducted over 2000-03, twelve general real estate research topics and twenty-seven specific real estate research topics were common to all four surveys and form the basis for the survey analysis in this research. For these thirty-nine research topics, only slight changes in wording were used in the four surveys to accommodate differences in local real estate terminology.1 The earlier 1992 U.S. survey (Ziering and Worzala, 1997) was not included in this comparative study as the twenty-seven specific real estate research topics were not included and only a subset of the twelve general real estate research topics were involved.
Real estate fund managers were asked to assess how important they believed each real estate research topic was. All questions were scored on a five-point rating scale," ranging from 1 = "not important" to 5 = "vitally important."
Exhibit 1 gives details of the survey respondents in these four real estate fund manager surveys. Depending on the survey, 30-79 real estate fund managers participated in each survey, with a total of 227 respondents across the four surveys.3
Focused on the research needs of the institutional investor, broader real estate research topics relevant to other groups (e.g., housing, real estate development) were not considered in these surveys.
Statistical Analysis
Average ratings for each of the thirty-nine general and specific real estate research topics were assessed for each of the four countries surveyed. Correlations were used to compare the real estate research priorities from the four country surveys.
To assess the underlying real estate research "dimensions" in the twelve general real estate research topics and the twenty-seven specific real estate research topics, principal component analysis (Everitt and Dunn, 2001) was applied to the four groups of respondents. Principal component analysis (PCA) is a multivariate analysis technique in which the underlying dimensions in the survey data are examined. Typically, a small number of dimensions arc extracted that explain a significant proportion of the total variation. A practical "real estate" interpretation can often be given to these major underlying dimensions, although meaningful interpretations are often not possible for the less significant dimensions.
General Real Estate Research Priorities
Analysis of General Real Estate Research Priorities
Exhibit 2 presents the average scores and respective ranks for the twelve general real estate research topics for the US, Australia, Germany and U.K. real estate fund manager surveys.
While differences occurred amongst the four surveys, the top four general real estate research priorities were:
1. The role of real estate in a mixed-asset portfolio;
2. Real estate and portfolio risk management;
3. Performance measures for real estate; and
4. Diversification within real estate portfolios.
In particular, the role of real estate in a mixed-asset portfolio was ranked first in the U.K. and Australia surveys, and was in the top four priorities for the corresponding U.S. and Germany surveys.
The low priority given to the role of international real estate in a portfolio in the U.S., U.K. and Australia surveys was surprising, given the significant recent institutional interest in incorporating international real estate in real estate portfolios, particularly via indirect real estate investments such as real estate investment trusts (REITs) and listed property trusts (LPTs) (Steinert and Crowe, 2001).
The high priority given to the role of international real estate in a portfolio in the Germany survey (ranked second) reflects the more flexible foreign investment legislation (Fourth Financial Market Promotion Act) introduced in Germany in July 2002. This sees the previous restriction on non-European Economic Area investment of a maximum 20% of fund assets replaced by a "currency-risk" ceiling of 30% of fund assets. This has resulted in considerable recent activity by German funds (e.g., Deka Immobilien Investment GmbH and DIFA Deutsche Immobilien Fonds AG) in acquiring commercial real estate in the U.S. (Jones Lang LaSalle, 2002), with over $5 billion invested by German funds in U.S. commercial real estate over January 2002-May 2003. Other factors influencing this high priority in the German survey for international real estate investments include the introduction of the Euro as the common European currency, effectively eliminating exchange rate risk for German real estate investors in Europe.
The major differences between the U.S. survey and the U.K., Australia and Germany surveys were the higher U.S. priority given to microeconomic factors affecting real estate and demographic changes affecting real estate. Similarly, a lower U.S. priority was given to real estate and portfolio risk management.
The extent of these differences in general research priorities is shown in the cross-country correlations detailed in Exhibit 3. The U.S. priorities were not significantly correlated with any of the U.K., Australia and Germany priorities (average correlation = 0.21), compared to an average direct correlation of 0.59 across the U.K., Australia and Germany surveys. The highest significant correlations were for the Australia/UK, (correlation = 0.81) and Australia/Germany (correlation = 0.61) priorities.
A range of factors are likely contributors to the differences between the U.S. and the U.K., Australia and Germany surveys. These factors include:
* The large and self-contained nature of the U.S. real estate market, compared to the strong linkages and communication between U.K. firms in Germany and German banks in the U.K.; similarly with the strong economic and business linkages between the U.K. and Australia;
* The strong reliance by U.S. institutional investors on a sophisticated advisory and investment management industry (e.g., Jones Lang LaSalle) to have detailed real estate expertise, compared to the typically "inhouse" expertise scenario for the U.K. and Australia;
* U.K. and Australian institutional investors have historically held significantly more real estate in their portfolios than their U.S. equivalents; this typically results in more institutional familiarity with real estate as an asset class than seen for real estate managers in U.S. pension funds;
* U.K., German and Australian institutional investors have a longer history of investing in real estate than their U.S. equivalents; this further reinforces their institutional familiarity with real estate as an asset class; and
* Real estate fund managers in the U.S. have not necessarily been formally trained in the real estate discipline, often being CFA-accredited compared to having real estate or finance degree backgrounds, whereas their equivalents in the U.K. are typically trained in RICS-accredited real estate degree programs. This difference in educational background has significant implications for understanding real estate as an asset class.
Identifying Dimensions in General Real Estate Research Priorities
Using principal component analysis, from the twelve general real estate research topics, Exhibit 4 indicates the number of underlying real estate "dimensions" and level of total variation explained for the four surveys, with Exhibit 5 presenting the PCA factor weights for the underlying dimensions for the U.K., Australian, German and U.S. analyses of the general real estate research priorities. The PCA results were generally consistent, identifying four or five real estate dimensions and accounting for 63.7%-70.2% of the total variation in each case.
All dimensions from each real estate fund manager survey were readily interpreted in a real estate context. The real estate dimensions that dominated across the four surveys were:
1. Changing real estate environment;
2. Strategic real estate issues; and
3. Role of real estate in portfolio.
These dimensions reflect the broad, strategic issues relating to real estate research. In particular, the changing real estate environment was the dominant real estate dimension in all surveys (except the U.S. survey), accounting for 13.1%-21.1% of the total variation explained. This further reinforces the differences between the U.S. survey and the U.K., Australia and Germany surveys.
Specific Real Estate Research Priorities
Analysis of Specific Real Estate Research Priorities
The average scores and respective ranks for the twenty-seven specific real estate research topics for the U.K., Australia, Germany and U.S. real estate fund manager surveys are shown in Exhibit 6. Compared to the general real estate research priorities, there was considerably more variation in the specific real estate research priorities across the surveys of the four countries. This was evident in that no specific real estate research topic was ranked in the top four priorities in more than 50% of the surveys.
Across the four surveys, the top six specific real estate research priorities were:
1. Impact of capital flows in and out of real estate markets;
2. Existence and predictability of real estate cycles;
3. Diversification within a mixed-asset portfolio; and
4. Diversification within a real estate portfolio.
5. Forecasting methodologies for markets, results, returns; and
6. Real estate disposal and exit strategies.
The other topic that ranked highly across individual surveys was taxation factors affecting real estate (U.K. and Germany). The lower priority given to taxation factors in the U.S. and Australia surveys reflect the significant role of REITs in the U.S. and LPTs in Australia, with both having tax-exempt status.
Specific real estate research priorities average scores in each survey were lower than that seen for the general real estate research priorities average scores, reflecting the higher priority given by real estate fund managers to the broader strategic real estate issues, rather than the more specific real estate topics.
The extent of the differences in these specific real estate research priorities is shown in the cross-country correlations in Exhibit 7. Significant correlations are seen between the U.K., Australia and Germany specific priorities (average correlation = .56), with no significant correlations seen for the U.S. specific priorities with each of the U.K., Australia and Germany survey priorities (average correlation = .18). This lesser correlation with the U.S. survey results for the specific real estate research priorities was also consistent with the lesser correlation seen in the general real estate research priorities.
In particular, the higher priority in the U.S. survey given to appraisal issues (priority 6-7) compared to the other three surveys (priority 12-19) reflects concerns over the use of the NCREIF Index as a customized real estate portfolio benchmark, particularly in comparison to the U.K. Investment Property Databank (IPD) indices and the Australia Property Council of Australia (PCA) indices and the higher level of academic awareness concerning the effectiveness of using valuations as a proxy for real estate market performance. Similarly, the lesser priority in the U.K., Australia and Germany surveys given to the impact of e-commerce on real estate demand (priority 23-27) compared to the U.S. survey (priority 12) reflects the timing of the surveys (2000 versus 2001-03) and the greater technological penetration in the real estate sector since the U.S. survey in 2000.
Identifying Dimensions in Specific Real Estate Research Priorities
From the twenty-seven specific real estate research topics, Exhibit 8 indicates the PCA results for the number of underlying real estate "dimensions" and the level of total variation explained in the four surveys.4 The PCA results were generally consistent, identifying 8-9 dimensions and accounting for 69.3%-76.9% of the total variation in each case.
With 8-9 dimensions identified per survey, the vast majority of dimensions were able to be given a real estate interpretation; particularly the more significant dimensions that accounted for a large component of the total variation explained. The lack of a real estate interpretation for some dimensions was most evident in the higher order dimensions for the Germany and U.S. surveys.
The real estate dimensions that dominated across the four surveys were:
1. Changing real estate environment (found in 3 of the 4 surveys);
2. Specific real estate market dynamics (found in 3 of the 4 surveys);
3. Diversification in portfolio (found in all 4 surveys); and
4. International real estate investment (found in 3 of the 4 surveys).
The changing real estate environment was the dominant real estate dimension in all surveys (except the Germany survey), accounting for 9.9%-14.9% of the total variation explained and being the most important real estate dimension in three of the four surveys.
Conclusion
These surveys have clearly identified the general and specific real estate research priorities for real estate fund managers in the U.S., U.K., Australia and Germany. These priorities should be useful for real estate fund managers, as well as to real estate researchers regarding potential priority real estate research topics suitable for research funding from leading real estate industry groups such as the Pension Real Estate Association (U.S.), Real Estate Research Institute (U.S.), Royal Institution of Chartered Surveyors (U.K.), Investment Property Forum (U.K.), German Society of Property Researchers (Germany) and Property Council of Australia (Australia).
The role of real estate in a mixed-asset portfolio and real estate and portfolio risk management figure prominently amongst the general real estate research priorities. Many of the dimensions identified using PCA have a clear real estate interpretation; particularly relating to the changing real estate environment, strategic real estate issues and the role of real estate in the portfolio. Importantly, when comparing the results of the four different surveys, there is a much closer alignment of the real estate research priorities in the U.K., Australia and Germany than found in the U.S.
It is hoped that the results of this research on the real estate research priorities across countries will be the catalyst to future research initiatives in this crucial area of real estate research for members of ARES, ERES, PRRES and AsRES.
Introduction
Real estate research has taken on increased importance in recent years in the international arena. The establishment of the regional real estate societies (particularly ARES, ERES, PRRES and AsRES) and their annual conferences have been key catalysts to this expanded real estate research agenda, with much of this research having a strong real estate industry focus. As such, general real estate research areas have been identified by leading real estate academics in the United States and the United Kingdom (Lusht, 1993; Webb, 1997; Jaffe, 1998; Crosby, 2000; Worzala, 2002; and Adair, Crosby, Lim and Watkins, 2003), as well as by leading U.S. and Australian real estate practitioners (Winograd, 1999; Souza, 2000; Parker, 2001; and Steinert and Crowe, 2001).
To more fully assess the real estate research directions and priorities for U.S. institutional investors, extensive real estate industry surveys have been funded by the National Council of Real Estate Investment Fiduciaries (NCREIF) in 1992 (Ziering and Worzala, 1997) and the Pension Real Estate Association (PREA) in 2000 (Worzala, Gilliland and Gordon, 2002), with Newell, Acheampong and Worzala (2002) conducting an equivalent real estate research priorities survey for Australia in 2001. In 2003, equivalent real estate research priority surveys have been conducted in the U.K. (Newell, McAllister and Worzala, 2003) and Germany (Schulte, Newell and Worzala, 2003).
Given these significant international real estate research developments, the purpose of this research is to compare the results of these four recent major international real estate surveys to examine the real estate research priorities of real estate fund managers in the U.S., U.K., Australia and Germany. Identification of these real estate research priorities will enable the more effective development of a real estate research agenda for real estate researchers in ARES, ERES, PRRES and AsRES, as well as for the emerging real estate societies of AfRES and LaRES.
Methodology
Surveys
Separate questionnaires involving general and specific real estate research topics for real estate fund managers were conducted in U.S. (Worzala et al., 2002), Australia (Newell et al., 2002), U.K. (Newell et al, 2003) and Germany (Schulte et al., 2003). From these four surveys conducted over 2000-03, twelve general real estate research topics and twenty-seven specific real estate research topics were common to all four surveys and form the basis for the survey analysis in this research. For these thirty-nine research topics, only slight changes in wording were used in the four surveys to accommodate differences in local real estate terminology.1 The earlier 1992 U.S. survey (Ziering and Worzala, 1997) was not included in this comparative study as the twenty-seven specific real estate research topics were not included and only a subset of the twelve general real estate research topics were involved.
Real estate fund managers were asked to assess how important they believed each real estate research topic was. All questions were scored on a five-point rating scale," ranging from 1 = "not important" to 5 = "vitally important."
Exhibit 1 gives details of the survey respondents in these four real estate fund manager surveys. Depending on the survey, 30-79 real estate fund managers participated in each survey, with a total of 227 respondents across the four surveys.3
Focused on the research needs of the institutional investor, broader real estate research topics relevant to other groups (e.g., housing, real estate development) were not considered in these surveys.
Statistical Analysis
Average ratings for each of the thirty-nine general and specific real estate research topics were assessed for each of the four countries surveyed. Correlations were used to compare the real estate research priorities from the four country surveys.
To assess the underlying real estate research "dimensions" in the twelve general real estate research topics and the twenty-seven specific real estate research topics, principal component analysis (Everitt and Dunn, 2001) was applied to the four groups of respondents. Principal component analysis (PCA) is a multivariate analysis technique in which the underlying dimensions in the survey data are examined. Typically, a small number of dimensions arc extracted that explain a significant proportion of the total variation. A practical "real estate" interpretation can often be given to these major underlying dimensions, although meaningful interpretations are often not possible for the less significant dimensions.
General Real Estate Research Priorities
Analysis of General Real Estate Research Priorities
Exhibit 2 presents the average scores and respective ranks for the twelve general real estate research topics for the US, Australia, Germany and U.K. real estate fund manager surveys.
While differences occurred amongst the four surveys, the top four general real estate research priorities were:
1. The role of real estate in a mixed-asset portfolio;
2. Real estate and portfolio risk management;
3. Performance measures for real estate; and
4. Diversification within real estate portfolios.
In particular, the role of real estate in a mixed-asset portfolio was ranked first in the U.K. and Australia surveys, and was in the top four priorities for the corresponding U.S. and Germany surveys.
The low priority given to the role of international real estate in a portfolio in the U.S., U.K. and Australia surveys was surprising, given the significant recent institutional interest in incorporating international real estate in real estate portfolios, particularly via indirect real estate investments such as real estate investment trusts (REITs) and listed property trusts (LPTs) (Steinert and Crowe, 2001).
The high priority given to the role of international real estate in a portfolio in the Germany survey (ranked second) reflects the more flexible foreign investment legislation (Fourth Financial Market Promotion Act) introduced in Germany in July 2002. This sees the previous restriction on non-European Economic Area investment of a maximum 20% of fund assets replaced by a "currency-risk" ceiling of 30% of fund assets. This has resulted in considerable recent activity by German funds (e.g., Deka Immobilien Investment GmbH and DIFA Deutsche Immobilien Fonds AG) in acquiring commercial real estate in the U.S. (Jones Lang LaSalle, 2002), with over $5 billion invested by German funds in U.S. commercial real estate over January 2002-May 2003. Other factors influencing this high priority in the German survey for international real estate investments include the introduction of the Euro as the common European currency, effectively eliminating exchange rate risk for German real estate investors in Europe.
The major differences between the U.S. survey and the U.K., Australia and Germany surveys were the higher U.S. priority given to microeconomic factors affecting real estate and demographic changes affecting real estate. Similarly, a lower U.S. priority was given to real estate and portfolio risk management.
The extent of these differences in general research priorities is shown in the cross-country correlations detailed in Exhibit 3. The U.S. priorities were not significantly correlated with any of the U.K., Australia and Germany priorities (average correlation = 0.21), compared to an average direct correlation of 0.59 across the U.K., Australia and Germany surveys. The highest significant correlations were for the Australia/UK, (correlation = 0.81) and Australia/Germany (correlation = 0.61) priorities.
A range of factors are likely contributors to the differences between the U.S. and the U.K., Australia and Germany surveys. These factors include:
* The large and self-contained nature of the U.S. real estate market, compared to the strong linkages and communication between U.K. firms in Germany and German banks in the U.K.; similarly with the strong economic and business linkages between the U.K. and Australia;
* The strong reliance by U.S. institutional investors on a sophisticated advisory and investment management industry (e.g., Jones Lang LaSalle) to have detailed real estate expertise, compared to the typically "inhouse" expertise scenario for the U.K. and Australia;
* U.K. and Australian institutional investors have historically held significantly more real estate in their portfolios than their U.S. equivalents; this typically results in more institutional familiarity with real estate as an asset class than seen for real estate managers in U.S. pension funds;
* U.K., German and Australian institutional investors have a longer history of investing in real estate than their U.S. equivalents; this further reinforces their institutional familiarity with real estate as an asset class; and
* Real estate fund managers in the U.S. have not necessarily been formally trained in the real estate discipline, often being CFA-accredited compared to having real estate or finance degree backgrounds, whereas their equivalents in the U.K. are typically trained in RICS-accredited real estate degree programs. This difference in educational background has significant implications for understanding real estate as an asset class.
Identifying Dimensions in General Real Estate Research Priorities
Using principal component analysis, from the twelve general real estate research topics, Exhibit 4 indicates the number of underlying real estate "dimensions" and level of total variation explained for the four surveys, with Exhibit 5 presenting the PCA factor weights for the underlying dimensions for the U.K., Australian, German and U.S. analyses of the general real estate research priorities. The PCA results were generally consistent, identifying four or five real estate dimensions and accounting for 63.7%-70.2% of the total variation in each case.
All dimensions from each real estate fund manager survey were readily interpreted in a real estate context. The real estate dimensions that dominated across the four surveys were:
1. Changing real estate environment;
2. Strategic real estate issues; and
3. Role of real estate in portfolio.
These dimensions reflect the broad, strategic issues relating to real estate research. In particular, the changing real estate environment was the dominant real estate dimension in all surveys (except the U.S. survey), accounting for 13.1%-21.1% of the total variation explained. This further reinforces the differences between the U.S. survey and the U.K., Australia and Germany surveys.
Specific Real Estate Research Priorities
Analysis of Specific Real Estate Research Priorities
The average scores and respective ranks for the twenty-seven specific real estate research topics for the U.K., Australia, Germany and U.S. real estate fund manager surveys are shown in Exhibit 6. Compared to the general real estate research priorities, there was considerably more variation in the specific real estate research priorities across the surveys of the four countries. This was evident in that no specific real estate research topic was ranked in the top four priorities in more than 50% of the surveys.
Across the four surveys, the top six specific real estate research priorities were:
1. Impact of capital flows in and out of real estate markets;
2. Existence and predictability of real estate cycles;
3. Diversification within a mixed-asset portfolio; and
4. Diversification within a real estate portfolio.
5. Forecasting methodologies for markets, results, returns; and
6. Real estate disposal and exit strategies.
The other topic that ranked highly across individual surveys was taxation factors affecting real estate (U.K. and Germany). The lower priority given to taxation factors in the U.S. and Australia surveys reflect the significant role of REITs in the U.S. and LPTs in Australia, with both having tax-exempt status.
Specific real estate research priorities average scores in each survey were lower than that seen for the general real estate research priorities average scores, reflecting the higher priority given by real estate fund managers to the broader strategic real estate issues, rather than the more specific real estate topics.
The extent of the differences in these specific real estate research priorities is shown in the cross-country correlations in Exhibit 7. Significant correlations are seen between the U.K., Australia and Germany specific priorities (average correlation = .56), with no significant correlations seen for the U.S. specific priorities with each of the U.K., Australia and Germany survey priorities (average correlation = .18). This lesser correlation with the U.S. survey results for the specific real estate research priorities was also consistent with the lesser correlation seen in the general real estate research priorities.
In particular, the higher priority in the U.S. survey given to appraisal issues (priority 6-7) compared to the other three surveys (priority 12-19) reflects concerns over the use of the NCREIF Index as a customized real estate portfolio benchmark, particularly in comparison to the U.K. Investment Property Databank (IPD) indices and the Australia Property Council of Australia (PCA) indices and the higher level of academic awareness concerning the effectiveness of using valuations as a proxy for real estate market performance. Similarly, the lesser priority in the U.K., Australia and Germany surveys given to the impact of e-commerce on real estate demand (priority 23-27) compared to the U.S. survey (priority 12) reflects the timing of the surveys (2000 versus 2001-03) and the greater technological penetration in the real estate sector since the U.S. survey in 2000.
Identifying Dimensions in Specific Real Estate Research Priorities
From the twenty-seven specific real estate research topics, Exhibit 8 indicates the PCA results for the number of underlying real estate "dimensions" and the level of total variation explained in the four surveys.4 The PCA results were generally consistent, identifying 8-9 dimensions and accounting for 69.3%-76.9% of the total variation in each case.
With 8-9 dimensions identified per survey, the vast majority of dimensions were able to be given a real estate interpretation; particularly the more significant dimensions that accounted for a large component of the total variation explained. The lack of a real estate interpretation for some dimensions was most evident in the higher order dimensions for the Germany and U.S. surveys.
The real estate dimensions that dominated across the four surveys were:
1. Changing real estate environment (found in 3 of the 4 surveys);
2. Specific real estate market dynamics (found in 3 of the 4 surveys);
3. Diversification in portfolio (found in all 4 surveys); and
4. International real estate investment (found in 3 of the 4 surveys).
The changing real estate environment was the dominant real estate dimension in all surveys (except the Germany survey), accounting for 9.9%-14.9% of the total variation explained and being the most important real estate dimension in three of the four surveys.
Conclusion
These surveys have clearly identified the general and specific real estate research priorities for real estate fund managers in the U.S., U.K., Australia and Germany. These priorities should be useful for real estate fund managers, as well as to real estate researchers regarding potential priority real estate research topics suitable for research funding from leading real estate industry groups such as the Pension Real Estate Association (U.S.), Real Estate Research Institute (U.S.), Royal Institution of Chartered Surveyors (U.K.), Investment Property Forum (U.K.), German Society of Property Researchers (Germany) and Property Council of Australia (Australia).
The role of real estate in a mixed-asset portfolio and real estate and portfolio risk management figure prominently amongst the general real estate research priorities. Many of the dimensions identified using PCA have a clear real estate interpretation; particularly relating to the changing real estate environment, strategic real estate issues and the role of real estate in the portfolio. Importantly, when comparing the results of the four different surveys, there is a much closer alignment of the real estate research priorities in the U.K., Australia and Germany than found in the U.S.
It is hoped that the results of this research on the real estate research priorities across countries will be the catalyst to future research initiatives in this crucial area of real estate research for members of ARES, ERES, PRRES and AsRES.
Thursday, December 20, 2007
Los Angeles continues to be a real estate hot spot
Study says viability will continue for at least five years
Despite tightening capital availability and overbuilding in some markets, Los Angeles will be one of the hottest spots in the country for real estate investment in the next five years, according to a new study by the Big Six accounting firm Ernst & Young.
Los Angeles was ranked the top apartment real estate market in the country and second or third in the four other categories, according to the study, which featured rankings by 400 real estate experts from across the country.
Soaring demand for affordable housing and slumping returns from the overbuilt office market have led to a shift to apartment investing by the area developers and investors, said Rick Bobrow, western region director of real estate services for Ernst & Young.
With fewer and fewer Angelenos able to afford their own homes, demand for apartment housing is booming and will continue to rise over the next five years, the study concluded. That demand will fuel higher rental which, in turn, will translate to healthier investment returns for apartment owners.
The five sectors measured by the report were the central business district office, in which Los Angeles ranked third; suburban office, in which Los Angeles ranked second; warehouse, in which Los Angeles ranked third; retail, in which Los Angeles ranked second and apartment.
The report said that nationwide apartment and warehouse prices and rents will appreciate the most rapidly of the five sectors surveyed, with apartment prices expected to rise 4.2 percent and rent 4.5 percent a year. Warehouse prices are also expected to rise a swift 4.2 percent per annum and rent by 4.1 percent per year. Still, that will not keep pace with inflation, which is expected to rise by 4.8 percent per annum.
The performance of the various real estate sectors was directly related to whether they were in oversupply on the market, said Bobrow. "Apartments and warehouse came out looking the best because they have not been oversaturated with development in the past 10 years," he said.
Locally, recently released Ernst & Young figures revealed that office and industrial return on investment declined while retail return on investment rose from fourth quarter 1988 to fourth quarter 1989. Office prices rose by 7.7 percent, rent by 1.8 percent, and the capitalization rate, an indication of return on investment computed by dividing a property's net annual operating income by its purchase price, declined by 1.5 percent for office properties.
Industrial prices appreciated even more slowly throughout the country, by .9 percent from fourth quarter 1988 to fourth quarter 1989. Industrial rents increased by 4.3 percent and the capitalization rate declined by 1.2 percent over the same period.
Capitalization rates for office and industrial properties have been declining since 1985.
The picture was somewhat brighter for retail properties. Prices appreciated by 7.6 percent, rents increased by 4.0 percent, and the capitalization rate reversed four straight years of decline and increased by 2.5 percent from fourth quarter 1988 to fourth quarter 1989.
Despite the decline in the local office capitalization rate, Bobrow boosted Los Angeles' office market future. "The office situation is improving due to a contraction of capital and a slowing down of overbuilding," Bobrow said. "It's a very diverse market and it's becoming the financial capital of the United States."
Bobrow and other local real estate experts also noted activity in several niche markets. Investors have shown increasing interest in hotels and community centers such as power and superpower centers, and golf courses for Japanese investors.
"There's tremendous demand for neighborhood shopping centers anchored by food and drug stores," said David Doupe, senior equity director of the financial services group of Cushman & Wakefield of California.
Despite comparatively high marks for the local real estate markets, many real estate experts said that Los Angeles is suffering from the same credit problems that are wracking the nation.
Developers and investors alike are having difficulty obtaining advances, said Richard Lund, regional sales manager of investment properties for the western region of Grubb & Ellis Co. That, he said, will drive prices down as many developers sell because they can't get refinancing.
Problems exist for many developers and investors where pro-forma rents on loan documents have exceeded realized rents. That has led to difficulty replacing expensive construction loans with takeout financing, he said.
The income-debt servicing discrepancy has led some observers to predict a major price adjustment in the local real estate market.
"I maintain that you will have a dramatic escalation in rents or a depreciation in property values," said Paul Debban, managing director of Reorganized Securities Group, a downtown Los Angeles-based bankruptcy representation firm.
With banks tightening lending requirements and savings and loans largely limited to home loans, the result has been an investors market for the few local investors with sufficient capital and real estate experience, he said.
"Right now affluent people have their pick of the projects," said Ron Saienni, president of Quantum Development of Newport Beach.
The financial squeeze is likely to continue indefinetely, Lund said. "The problem won't go away until financial institution problems go away," he said.
Another set of institutional investors, pension funds, have also slowed their activity nationwide and "unfortunately in Los Angeles County," Doupe said. "I think it is a short term occurance; most indicators are still positive."
Lund and other real estate experts said that they have advised their clients to invest in areas of the county, such as the Westside, where growth limitation ordinances have been passed.
Small investors may be able to take advantage of sales of small properties by developers who must sell the properties at reduced prices to pay current construction costs on other projects, he said.
A bright investment spot in the office market may be "vanity office," buildings with distinctive architecture that appeals to professionals and usually have a lower turnover, in areas such as Mid-Wilshire, Venice, Pasadena and Santa Monica, said Sanford Goodkin, national executive director of the KPMG Peat Marwick/Goodkin Real Estate Consulting Group. "These will go through a real renaissance."
Goodkin warned, however, that real estate novices thinking of investing should deal with builders with good reputations and realize that for the moment many real estate opportunities in the county are not golden investments. "Many people think they are sophisticated because they have made money previously in real estate -- well, all the rules have changed."
p
Despite tightening capital availability and overbuilding in some markets, Los Angeles will be one of the hottest spots in the country for real estate investment in the next five years, according to a new study by the Big Six accounting firm Ernst & Young.
Los Angeles was ranked the top apartment real estate market in the country and second or third in the four other categories, according to the study, which featured rankings by 400 real estate experts from across the country.
Soaring demand for affordable housing and slumping returns from the overbuilt office market have led to a shift to apartment investing by the area developers and investors, said Rick Bobrow, western region director of real estate services for Ernst & Young.
With fewer and fewer Angelenos able to afford their own homes, demand for apartment housing is booming and will continue to rise over the next five years, the study concluded. That demand will fuel higher rental which, in turn, will translate to healthier investment returns for apartment owners.
The five sectors measured by the report were the central business district office, in which Los Angeles ranked third; suburban office, in which Los Angeles ranked second; warehouse, in which Los Angeles ranked third; retail, in which Los Angeles ranked second and apartment.
The report said that nationwide apartment and warehouse prices and rents will appreciate the most rapidly of the five sectors surveyed, with apartment prices expected to rise 4.2 percent and rent 4.5 percent a year. Warehouse prices are also expected to rise a swift 4.2 percent per annum and rent by 4.1 percent per year. Still, that will not keep pace with inflation, which is expected to rise by 4.8 percent per annum.
The performance of the various real estate sectors was directly related to whether they were in oversupply on the market, said Bobrow. "Apartments and warehouse came out looking the best because they have not been oversaturated with development in the past 10 years," he said.
Locally, recently released Ernst & Young figures revealed that office and industrial return on investment declined while retail return on investment rose from fourth quarter 1988 to fourth quarter 1989. Office prices rose by 7.7 percent, rent by 1.8 percent, and the capitalization rate, an indication of return on investment computed by dividing a property's net annual operating income by its purchase price, declined by 1.5 percent for office properties.
Industrial prices appreciated even more slowly throughout the country, by .9 percent from fourth quarter 1988 to fourth quarter 1989. Industrial rents increased by 4.3 percent and the capitalization rate declined by 1.2 percent over the same period.
Capitalization rates for office and industrial properties have been declining since 1985.
The picture was somewhat brighter for retail properties. Prices appreciated by 7.6 percent, rents increased by 4.0 percent, and the capitalization rate reversed four straight years of decline and increased by 2.5 percent from fourth quarter 1988 to fourth quarter 1989.
Despite the decline in the local office capitalization rate, Bobrow boosted Los Angeles' office market future. "The office situation is improving due to a contraction of capital and a slowing down of overbuilding," Bobrow said. "It's a very diverse market and it's becoming the financial capital of the United States."
Bobrow and other local real estate experts also noted activity in several niche markets. Investors have shown increasing interest in hotels and community centers such as power and superpower centers, and golf courses for Japanese investors.
"There's tremendous demand for neighborhood shopping centers anchored by food and drug stores," said David Doupe, senior equity director of the financial services group of Cushman & Wakefield of California.
Despite comparatively high marks for the local real estate markets, many real estate experts said that Los Angeles is suffering from the same credit problems that are wracking the nation.
Developers and investors alike are having difficulty obtaining advances, said Richard Lund, regional sales manager of investment properties for the western region of Grubb & Ellis Co. That, he said, will drive prices down as many developers sell because they can't get refinancing.
Problems exist for many developers and investors where pro-forma rents on loan documents have exceeded realized rents. That has led to difficulty replacing expensive construction loans with takeout financing, he said.
The income-debt servicing discrepancy has led some observers to predict a major price adjustment in the local real estate market.
"I maintain that you will have a dramatic escalation in rents or a depreciation in property values," said Paul Debban, managing director of Reorganized Securities Group, a downtown Los Angeles-based bankruptcy representation firm.
With banks tightening lending requirements and savings and loans largely limited to home loans, the result has been an investors market for the few local investors with sufficient capital and real estate experience, he said.
"Right now affluent people have their pick of the projects," said Ron Saienni, president of Quantum Development of Newport Beach.
The financial squeeze is likely to continue indefinetely, Lund said. "The problem won't go away until financial institution problems go away," he said.
Another set of institutional investors, pension funds, have also slowed their activity nationwide and "unfortunately in Los Angeles County," Doupe said. "I think it is a short term occurance; most indicators are still positive."
Lund and other real estate experts said that they have advised their clients to invest in areas of the county, such as the Westside, where growth limitation ordinances have been passed.
Small investors may be able to take advantage of sales of small properties by developers who must sell the properties at reduced prices to pay current construction costs on other projects, he said.
A bright investment spot in the office market may be "vanity office," buildings with distinctive architecture that appeals to professionals and usually have a lower turnover, in areas such as Mid-Wilshire, Venice, Pasadena and Santa Monica, said Sanford Goodkin, national executive director of the KPMG Peat Marwick/Goodkin Real Estate Consulting Group. "These will go through a real renaissance."
Goodkin warned, however, that real estate novices thinking of investing should deal with builders with good reputations and realize that for the moment many real estate opportunities in the county are not golden investments. "Many people think they are sophisticated because they have made money previously in real estate -- well, all the rules have changed."
p
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