It’s too soon to expect another ’80s-style real estate boom, but there are hints this depressed industry is ready to perk up.
The signs of an improved market for offices, apartment buildings and warehouses are mostly spotty and ancedotal-too faint or recent to register very impressively.
But real estate brokers say tenants looking for office space today are finding it harder to get the kind of deals common a year ago. Once landlords stop making concessions such as giving the first year’s rent for free and making tenant improvements at no cost, rent increases will follow, raising property values, experts say.
Already, there is a rush of money into real estate investments from individuals and institutions that believe the market’s prognosis is good enough to justify diverting money from what have been better prospects, such as stocks.
Real estate investment trusts (REITs)-pools that invest in property or mortgages the way mutual funds invest in stocks-are issuing new shares at a record pace: $13 billion worth expected this year compared to $2 billion in 1992.
“You had a tremendous plunge” in rents and office-building values starting in the late 1980s, said Julien J. Studley, head of the nationwide real estate firm that bears his name.
“The plunge is stopped. That’s dramatic. The elevator is not going down anymore. It `may’ be going up.”
Alfred W. Schwacke Jr., executive vice president of Grubb & Ellis in Philadelphia, said his office had sold $100 million worth of commercial real estate so far this year, which is nearly double its 1992 sales.
Prices remain low by ’80s standards, with most properties selling for far less than it would cost to build them new today, he said.
But Schwacke also said there were growing numbers of would-be buyers out looking. And on the rental front, he sees landlords being less inclined to sign up some of the shaky-credit tenants they were only too happy to get last year.
“There is a confidence that has come back into real estate,” he said. The Building Owners and Managers Association International said that U.S. office vacancy rates have declined one-half of a percentage point in each of the last four quarters, most recently to 17 percent.
“We’ve now reached the lowest vacancy rate since the fourth quarter of 1985,” Thomas B. McChesney, president of the association, said.
Barton M. Biggs, a securities analyst for Morgan Stanley in New York, told investors this fall that commercial real estate had stopped declining and entered a “big, wide, round bottom” that could last 18 to 24 months.
“Although it would be premature to claim that a bull market in commercial real estate has begun, the bear market is over. True bargains are available,” he said.
Studley’s firm calculates office vacancy rates in 13 major markets. Vacancies remain high almost everywhere, exceeding 20 percent in such markets as Houston, downtown Los Angeles and downtown Chicago. And Studley said that low rents, high vacancies and the high cost of concessions to tenants leave the typical Class A skyscraper in the red.
But his firm found that 12 of the 13 markets had lower vacancy rates in this September-October reporting period than they did at the start of the year.
Nationwide figures show that rental rates are not increasing, but there are a number of markets where rents are leveling after years of decline. In midtown New York, for example, rents in 1992 and 1993 have held steady at a little over $40 a square foot in new buildings and $26 in older buildings, after dropping from about $47 and $30 in 1990.
McChesney, of the Building Owners and Managers Association International, said the value of landlord concessions has dropped 10 percent from its peak.
“In many cities and suburbs around the country, the supply of Class A space is tightening, even if rents haven’t yet begun to rise very much,” he said. “That’s simply because Class C tenants are moving up to Class B space, and Class B tenants are ascending to Class A space.”
Studley noted that because commercial deals often take a year or longer to hammer out, today’s statistics don’t really show how the market has changed in the last year.
In 1992, tenants often were able to get out of high-rent leases that still had years to run by offering to sign longer leases at lower rents. Landlords went along because they feared that departing tenants might not be replaced for ages-and future rents might be even lower.
“In 1992, owners became really extremely anxious to make transactions,” Studley said. “And tenants became really aggressive. But in some markets, the best stock has been taken off the market, it was leased . . .
“In the past, tenants figured they could wait (to sign new leases) because the prices were going to be cheaper. That’s very different now. Now, owners are beginning to think maybe it’s a good idea to wait (to negotiate new leases), because prices are going to be higher. Psychologically, that’s a turning point in the market.
“There is going to be a much quicker escalation of rent than people anticipate.”
Another highly regarded survey is done every quarter by Frank Russell Co. and the National Council of Real Estate Investment Fiduciaries, both of Tacoma, Wash. It looks at the returns-a property’s appreciation and the income it generates after expenses-of unmortgaged investment properties owned by institutions such as pension funds.
In the first six months of 1993, total return for the 1,684 properties in the survey was zero. That’s nothing to brag about, perhaps, but in the previous year, the properties lost 3.7 percent, and over the previous two years, they lost 5.26 percent.
Over the last three years, the value of appraised property has declined by more than 10 percent a year, but the drop slowed in the past year to the low single digits, the study found.
A breakdown shows that apartment building returns are growing, as they have been for five years. Office buildings are losing money, but at a much lower rate than in the past few years. Retail space is making money after three years of losses. Overall returns are best in the Midwest and South, and worst in the East and West.
On Wall Street, underwriters are rushing to capitalize on perceptions that commercial real estate returns will pick up. There are also reports of money flooding into “opportunity funds”-real estate pools for wealthy or institutional investors.
The National Association of Real Estate Investment Trusts said the $13 billion in new REIT share offerings expected this year compared to the previous record of less than $4 billion in 1985.
REITS take profits from rent and capital gains from sales and pay them to shareholders as dividends. REIT shares are traded on major exchanges like other stocks.
Institutions and individuals have been pulling money out of low-yielding bonds and bank deposits and are eager to invest in REITS, which have been paying dividends averaging about 7 percent this year.
Demand has driven up share prices, so that REIT returns-the combination of share price and dividends-averaged 25.8 percent over the last year, NAREIT said.
Still, experts caution that a hearty real estate market still may not be near. Also, a rise in interest rates or fear of inflation could make REIT dividends less attractive, causing a drop in REIT share prices.
Although commercial real estate may have hit bottom, many experts don’t expect it to skyrocket again the way it did in the 1980s.
McChesney said a number of factors were altering the market: Tenant companies have learned to get by with smaller staffs, fewer young people are moving into the workforce than in the ’70s and ’80s, and computer and communications advances make it less and less necessary to have large centralized offices.
