COVER STORY, JANUARY 2006

BROKER OUTLOOK 2006
Brokers from around the Northeast forecast the real estate market in 2006.
Interviews by Nicole Thompson

Northeast Real Estate Business recently spoke with brokers around the region about their forecasts for 2006. The brokers included: Eric Anton, a senior managing director with Eastern Consolidated in New York City; Steven Gartner, the president of Metro Commercial Real Estate in Conshohocken, Pennsylvania; Costas Hrousis, a senior advisor with Sperry Van Ness/Imperial Realty in Allentown, Pennsylvania; Peter Lindner, an associate with NAI DG Hart in New York City; Nicholas Malagisi, a senior advisor and national director of self storage with Sperry Van Ness in Buffalo, New York; Jack Soloff, a senior vice president with the office group of Grubb & Ellis in Philadelphia; and Bart Zimmerman, a vice president with Itzhaki Properties in New York City.

NREB: Which sectors of the market performed well in 2005?

Lindner: 2005 was a banner year for Manhattan's office and investment markets. Vacancy rates continued to drop throughout Midtown Manhattan, reaching a low of 7 percent during the third quarter 2005 while investment sales scorched 2004 numbers with more than $18 billion of volume during 2005. Average asking rents for Class A, B and C buildings dipped slightly to $47.96 per square foot while average Class A rents peaked at $56.86 and remain their highest since the third quarter 2003. Retail, not to be outdone, also realized increased activity with deals in some of New York City's priciest corridors going north of $1,000 per square foot.

Zimmerman: Multi-use development projects.

Hrousis: Bulk land sales for residential development, bulk residential lots, multifamily land, apartments, retail and industrial flex all performed well in the Lehigh Valley area of Pennsylvania.

NREB: What is driving market activity?

Anton: At the moment, investors from around the globe are very bullish on New York City real estate. Also, the residential market, though a bit less frantic than last quarter, still continues to amaze everyone in terms of price per square foot for residential condominium units as well as rental rates for apartments in good locations.

Hrousis: In the Lehigh Valley, market activity is being driven by the influx of people moving into the market from New Jersey and New York. This is driving residential and retail sectors of the market.

NREB: Which sectors will continue to do well in 2006?

Hrousis: Retail land sales will continue as retailers attempt to fill in to secondary markets. Residential bulk land sales will continue to do well because of the length of entitlement process and the lack of available finished lot inventory.

Zimmerman: Multifamily or condo development with strong retail. As the economy gets stronger and more people are working, it will drive down retail vacancies and improve retail demand.

Anton: All property types did well in 2005, and it is our expectation that retail properties will continue to grow in terms of demand and price per square foot, whereas office building pricing may level off and land for development will also gently level off given the tremendous growth of the past 2.5 years. The office leasing market continues to be somewhat sluggish and therefore increases in value cannot continue to advance. Similarly, end-unit condo sales are slowing somewhat, and this will dampen the enthusiasm for record prices for new sites.

Lindner: The Midtown office market, which toward the end of the third quarter made the shift from a market favoring tenants to one where the tenant and the landlord have equal bargaining power, looks to perform well going into 2006.   As vacancy continues to drop and law firms and financial institutions gear up for a strong 2006, we expect rent concessions in the form of work contribution and free rent to drop in kind. We expect the investment sales market to lose some of the ferocious velocity it gained during 2005 as interest rates rise, but top trophy properties and four-star hotels should still command top dollar.

NREB: What areas of the Northeast   should people keep an eye on for 2006?

Anton: Monmouth County in New Jersey seems to be an undervalued market both in terms of its residential and commercial development potential. The county, just 60 miles southwest of Manhattan, is improving its transportation to New York City and continued growth should be forthcoming. Additionally, the northern Bronx should see tremendous growth in value given the continued transfiguration of this submarket.

Hrousis: Investors should keep their eyes on secondary markets to the large metro areas from New York and Philadelphia to Washington, D.C. These areas include the Lehigh Valley, Pennsylvania; Harrisburg, Pennsylvania; Dover, Delaware; and Southern New Jersey. Many national and regional developers and investors have entered these markets seeking value that they have not been able to find in the larger metro areas because of the fierce competition for sites and investment products in those markets.

NREB: What do you think will be the largest economic factors affecting commercial real estate in 2006?

Gartner: It's always the economy, and interest rates. We saw a general chill to the economy at the end of the summer when gas prices skyrocketed, and for retailers whose customers are very economical and value-minded, this can have a detrimental effect on consumer pocketbooks.

Anton: As usual, interest rates' fluctuation may determine the course of the investment sales market in 2006. Barring any catastrophic events, interest rates and general economic outlook should be the largest economic factors affecting the New York market.

Hrousis: Interest rates, inflation, job growth and the stock market will be the biggest factors affecting the market. If returns in the stock market come back, watch capital leave real estate and go back to the stock market.

Lindner: Two major economic factors that will affect the commercial real estate markets in 2006 are the equity markets and the schedule at which the Federal Reserve Bank looks to increase interest rates. As money becomes more expensive to borrow and the spread between real estate returns and traditional equity returns are driven closer together by the swarms of investors 2005 experienced, we expect non-traditional real estate investors to begin to back away from real estate deals.

Office

NREB: Which areas of the office market performed well in 2005?

Soloff: The western Philadelphia suburbs performed extremely well in 2005 with more than 1.6 million square feet of positive absorption as of the end of the third quarter 2005. With limited construction and strong tenant demand, there have been widespread declines in vacancy.

NREB: What is driving office market activity?

Soloff: Anecdotally, there has been a growth component in most lease transactions. We are seeing companies taking space for current and future planned expansions.

Lindner: The acquisition side of the office market has been driven mainly by law firms expanding and renewing leases in some of Manhattan's top buildings and financial services firms acquiring large blocks of space throughout Midtown and Lower Manhattan.

NREB: Are there any industries that you expect to show increased office demand in 2006?

Lindner: We expect law firms, who traditionally gain market share by adding lawyers and growing their firms, to fuel the office market in Manhattan through 2006. Various financial institutions, from private equity firms to traditional investment banks, are also gearing up for a strong deal-making year in 2006. We expect these industry players to drive both the acquisition and disposition side of the market as firms grow out of some of Manhattan's top, yet nearing full-occupancy, buildings.  

Anton: Wall Street had a great year in 2005, and it looks like the big Wall Street houses will continue to do well in 2006, and these companies may require additional office space in both Midtown and Downtown.

NREB: What trends are you seeing in the office market?

Zimmerman: More people working and an increased demand for space.

Hrousis: Activity starting to pick up; however, absorption is still slow.

Soloff: Vacancy rates have come down due to strong tenant demand as well as conversion of older office buildings to residential product.

Retail

NREB: Which types of retail will continue to do well in 2006?

Gartner: In retail, mega-box anchors and small national merchants, especially food and bank uses, will continue to flourish, as they are the hot retail categories in this market. Most of the junior anchors in categories such as electronics, housewares, sporting goods, and books have already penetrated the market, and they are focusing much of their expansion on other parts of the country where retail development is following population growth. Smaller, in-fill retail developments and redevelopments will continue to be prevalent.

NREB: What is driving market activity?

Gartner: Lack of quality, zoned sites continues to create a lack of supply for retailers, so many chains chase the same good location. There is also a bit of a growing gap between retailers' and landlords' rent expectations.

NREB: Are there any industries that you expect to show increased retail demand in 2006?

Gartner: We're clearly seeing the diminishing importance of the traditional mall-based department store, as the Federated-May merger is felt throughout the industry. As a result, discounters — like Target, Wal-Mart and Kohl's — are filling the void for customers as they grow in locations.

NREB: What trends are you seeing in the retail market?

Hrousis: The discount stores are competing for the best locations in the secondary markets, driving prices up.

Investment Sales

NREB: What trends are you seeing in the investment sales market?

Anton: Foreign investors continue to cherry-pick trophy locations in the investment sales category in New York City, especially the hotel market and major office buildings market.

Zimmerman: As condos become overpriced to develop you are going to see more demand for rental properties.

Lindner: The investment sales market saw a frenzied 2005, where buyers far outnumbered sellers and prices skyrocketed into territory previously thought to be unattainable. Toward the end of 2005 we saw international interest in trophy Class A office towers and historic four-star hotels. The Plaza Hotel, Essex House, Algonquin and Manhattan House all changed hands in nine-figure deals, and JPMorgan Chase and Verizon Wireless both utilized the market frenzy in 2005 to deploy multiple assets in Midtown for nine-figure returns. We expect this trend to continue.

Hrousis: Cap rates have stabilized around 7 percent for good product. There are still many investors in the market looking for stable cash flows from investment real estate. This segment of the market should stay strong as rumors of the capital gains rates increasing should keep sellers and buyers plentiful.

NREB: Do you expect an increased presence of tenancy-in-common (TIC)-structured deals?

Zimmerman: Until TICs become more liquid I don't think they will be popular in New York or the East Coast.

Hrousis: There are very few TIC deals in our market overall. I think that the TIC market may cool down as investors find other investment options that are more liquid and not as risky.

Anton: TIC deals are growing everyday and sophisticated investors getting more comfortable participating in these types of investments in order to accommodate 1031 exchange requirements.

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