COVER STORY, DECEMBER 2010

COLLIERS CALLS IT
What will 2011 bring to the commercial real estate industry?
By Jaime Lackey

As we move toward a new year and we see encouraging signs of an improving economy, we are optimistic that 2011 will bring recovery to the commercial real estate industry. To get a look at expectations for next year, Northeast Real Estate Business talked with Ross Moore, executive vice president of research with Colliers International. As Colliers’ chief economist, Moore is responsible for providing bottom-up and top-down analyses of commercial real estate markets across the U.S.

NREB: Which property types will do well in 2011?

Moore: Multifamily is the clear winner. Although I may be in the minority, I also think industrial will do well in 2011. Industrial is so closely tied to the global economy, which is on track to do well next year. Exports and global trade are already up. The latest International Monetary Fund (IMF) numbers show the global economy will grow 4.8 percent in 2010 and will only moderate marginally in 2011, with growth still coming in comfortably above 4.0 percent  — and, more importantly, back to levels experienced prior to the global financial crisis. With the world economy on track to post robust growth, global trade is expected to surge higher, increasing the demand for warehouse space across any market that is part of the global supply chain. I think people will be surprised at how quickly industrial properties will move in 2011. On the supply side, we’re almost at zero, once obsolescence is taken into account, and nothing is being built.

Office and retail will move painstakingly into recovery but there will be no sharp reversal like we will see with industrial markets. There is too much excess supply of retail and office properties, and these markets depend on jobs. We will see some job growth in 2011 but not enough to move the needle.

One year from now, we will see lower retail and office vacancy rates, but no sharp reversal. There are some good news markets, though. We are bullish on office and retail in both Boston and New York. These two cities are producing jobs, though they are not seeing tremendous growth yet. In fact, in terms of job growth, the September data shows that Boston is the Number 5 major market in the U.S. and New York is Number 17 (of the 46 major metros that Colliers International tracks).

NREB: Distressed properties did not hit the market in the numbers that many expected. How will this affect the market in 2011?

Moore:  A year ago, people were predicting at least 50 percent of 2010 commercial real estate sales would be distressed assets. In reality, there has been sufficient liquidity in the market so that we’ve had very few distressed sales — less that 15 percent of total sales.

This has been a “managed meltdown.” Underwater loans are getting worked out. I don’t see anything to suggest “pretend and extend” is going away immediately. Most banks and special servicers have no incentive to foreclose, so they continue to push things out. The trend toward extending loans is condoned by regulators so there is no pressure on the banks or special servicers.

Low interest rates have also played a role in the low volume of distressed property sales. A good many “distressed” properties are at floating rates, and they have the cash flow to service the debt. Companies keep making the payments in the hopes that building operations will recover and they will hold onto their assets.

Furthermore, we are seeing values bounce back for good quality real estate in select markets. This is setting the tone for property sales.

As values for quality properties bounce back, “pretend and extend” will begin to wane. In the meantime, we will likely see another wave of distressed property sales in 2011. A wave — not a tsunami. Investors can buy properties for 60 to 80 cents on the dollar — not 10, 20 or 30 cents on the dollar.

NREB: What are your predictions for foreign investment?

Moore: Although there is a huge appetite for U.S. real estate, foreign investors are far from being the largest buyer group. Little more than 10 percent of the total investment in any given month is from foreign sources. This is up from a couple of years ago when foreign investment accounted for 6 to 7 percent of purchases.

There just isn’t a lot of product to buy, and foreign investors are frustrated. Essentially, they are priced out of the market. Big funds want big core buildings, and these assets are not trading at prices they are willing to pay. The Number 1 source of foreign investment is Canada. We’ve seen some Canadian money and German money come into New York.

NREB: Overall, what do you expect for 2011?

Moore: The next 12 months will certainly be better than the last 12 months. I think that when we look back 12 months from now, we will see that we are in the beginning of a mild recovery now.

Certain markets and certain property types will do well. In fact, we will see some shockingly high prices paid for some assets due in large part to the low interest rates. To clarify, I think people outside the real estate industry will be shocked at the prices paid for buildings that cannot be filled while we are not creating a substantial number of jobs.

However, real estate will continue to be a preferred investment. Money is earning less than 1 percent interest whereas real estate is providing 5 percent returns. Why wouldn’t people buy something with greater return and where they can add value?

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