Commercial Real Estate Where Are We Now?

credit: R, Drummer  Co-Star
Similarly to A Year Ago, Conflicted Sentiments Rule The Day As Stretch Run For 2012 Presidential Election Draws Nearer

This time last year, the CRE industry was mired in a summer funk, buzzing over the potential negative effects of the European debt crisis, the U.S. debt crisis and slower-than-expected economic growth following a series of strong year-end indicators suggesting that property demand growth would pick up speed through the beginning of the year.

The latest crop of national investors surveys and leading indicators released over the last few days shows that same confused sentiment has returned, less than three months ahead of another historic U.S. presidential election. Sifting through current and leading indicators and sentiment survey finds a similarly murky picture of conditions in U.S. commercial real estate property markets and capital conditions.

First, The Good News

For the first time in what seems like an eon, the American Institute of Architects (AIA) has raised its outlook for construction spending in 2012 and through 2013, countering its previous forecast in January of slower growth in new construction.

A sharp spike in demand for industrial facilities this year, along with ongoing demand for hotels and retail projects, prompted the AIA to revise the 2.1% projected increase in the trade group’s January Consensus Construction Forecast to a 4.4% rise in spending this year for all nonresidential construction projects.


The semi-annual forecast, a survey of the nation’s leading construction forecasters, further projects a 6.2% increase in spending in 2013. Growth in commercial construction, including industrial facilities and warehouses, hotels, retail and office buildings, is expected to rise 5.7% this year and move into double-digit gains next year at 10.2%, according to the AIA.

Another potential leading indicator of CRE market conditions and lending, the volume of initial environmental site assessment (ESA) activity, increased 13.4% over the same period a year ago, the largest jump in the past 15 months, according to a study by Environmental Data Resources Inc.

A first-phase ESAs is ordered when there is a serious intent to arrange financing for an acquisition or to recapitalize an asset, and such reporting is strongly correlated with real estate lending, according to Joseph P. Derhake, president of Partner Engineering and Science Inc., a leading environmental and engineering consulting firm. Increasing volumes of ESAs means more capital is flowing back into the market.

In 2011, a year in which the volume of commercial and multifamily originations increased according to the Mortgage Bankers Association, the number of Phase 1 ESAs increased 7% over 2010. ESA activity in second-quarter 2012 is up 8.4% over the previous quarter, with 104,617 ESAs ordered in the first half of the year.

“If the past is prologue, we should see a continuing increase in commercial and multifamily originations through the end of the year,” Derhake said in the report.

The Not-So-Good News

However, there’s plenty of disappointing news to offset promising future indicators, and even AIA Chief Economist Kermit Baker acknowledged concerns over the “fiscal cliff” involving the effects of federal tax and spending policy and its expected fallout on construction spending.

“We will likely have a better sense after the presidential election what will happen with regards to the Bush-era tax cuts, Social Security payroll tax, extended unemployment, and deficit reduction plans that will have a ripple effect that will extend to the construction industry,” he said.

Taking a decided dimmer view, the Real Estate Roundtable released its Q3 Sentiment Survey, finding the outlook for CRE has again weakened and is not expected to improve much over the coming year except for pockets of strong activity and price appreciation in core “gateway markets,” and the multifamily segment.

One quarter ago, an overwhelming 74% of survey participants judged current conditions to be at least somewhat better than a year earlier, but only 60% expressed such views in the latest survey. Looking ahead, the percentage of CRE executives who expect conditions to be better a year from today dropped from 69% to 58% between the second and third quarter.

Roundtable president and CEO Jeffrey DeBoer said the latest survey “underscores the fragility and unevenness of the commercial real estate recovery, which closely tracks the pace of the broader U.S. economic recovery and which remains limited to top-notch assets in major metro markets.”

“Given the pervading sense of uncertainty hanging over the economy, the elections, looming budget and tax issues awaiting action on Capitol Hill, increasingly complex and overlapping regulatory burdens, and escalating worries about the eurozone, it’s not surprising that commercial real estate executives’ expectations for the year ahead are relatively lackluster.”

The hints of cautious optimism that emerged in the January-February survey began to evaporate by mid-year, when the Federal Reserve downgraded its projections for U.S. economic growth after three consecutive months of disappointing jobs data.

“Commercial real estate continues to face pressure from underlying economic problems, along with an erosion of property values and equity throughout much of the country, and a massive amount of loans coming due,” DeBoer said.

Separately, in Fannie Mae’s latest housing survey out this week, Americans’ confidence in the economy and their personal finances also continued to stall, though there were traces of a silver lining in respondents’ outlook for improvement in the housing market. In the GSE’s July 2012 National Housing Survey, respondents said they expect home prices to increase 1.7% in the next 12 months, down slightly from the survey high of 2.0% recorded in June.

“Not surprisingly, we see consumers’ attitudes about their household finances remain cautious in this month’s survey, and they continue to show signs of job worries and financial stress,” said Doug Duncan, senior vice president and chief economist of Fannie Mae. “However, it is encouraging to see that consumer expectations regarding housing largely continue to be upbeat.”

According to the survey, 11% of respondents — the lowest level recorded since the survey began in June 2010 — believe home prices will drop in the next year. Also, in the highest level seen since the survey’s inception, 16% of consumers say it is a good time to sell.

The percentage of respondents who said it was a good time to buy has remained steady at 73%.

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