Real Estate Forum - September 2011

$2 billion in the first half of the year, which reduced outstanding distressed retail properties yet to be worked out to approximately $27 billion, according to Real Capital Analytics.

Pricing for strip and neighborhood centers has remained relatively flat at an 8% average cap rate since the second quarter of 2010. While this is an improvement from the second quarter of 2009, when rates peaked at higher than 8.5%, they remain close to 90 bps wider than in 2008. Mall cap rates continued to tighten during the first half of the year despite an increasing number of malls listing for sale. Average cap rates were approximately 7.4% during the second quarter and July, still 80–90 bps wider than in 2008.

Despite an increase in new retail property listings, transaction volume is expected to fall somewhat during the second half—barring a large portfolio sale—as financing acquisitions becomes more difficult, vacancies increase and consumer spending and retail sales remain anemic.

MODEST RECOVERY CONTINUES FOR INDUSTRIAL PROPERTIES The industrial real estate sector continued its slow recovery during the second quarter and July, even as industrial production declined due to supply interruptions. Industrial production rebounded sharply in July as auto production surged and orders for business equipment increased. Concurrently, companies are continuing to adjust their logistics plans to reduce transportation and inventory costs, in many cases moving and/or expanding their warehouse and industrial locations, ultimately adding to the demand for industrial space. Adding to the need to rethink distribution networks is the expected 2014 completion of the expansion of the Panama Canal which promises to be the biggest shake up in U.S. distribution since advert shipping continues according to industry experts.

Industrial vacancy fell to a two-year low of 9.8% in
the first half of the year, down significantly from the
10.4% one year ago, according to Co-Star’s Mid-
Year 2011 Industrial Outlook and Review. Although
quarterly warehouse absorption was modest, the
market has enjoyed five consecutive quarters of
positive growth totaling 104 million square feet.
Vacancy rates have also benefited from record-low
new warehouse deliveries during the second
quarter.

With new supply limited during the second half of the year—only 5 million square feet of new warehouse construction was started in the second quarter—the industrial property sector should continue to slowly recover, even if manufacturing and export growth slows. Rents are expected to remain relatively flat, perhaps increasing one or two cents per foot by year-end.

Industrial property sales were $6.6 billion in the second quarter, up 64% from the year before. July sales declined to $1.6 billion from the $2.7 billion average in May and June according to Real Capital Analytics. Approximately two thirds of industrial sales were warehouse, and the remainder was flex space, where sales were bolstered by the sale of several large showrooms in Las Vegas and South Carolina. Average cap rates for industrial properties declined at the end of 2010 but have leveled at just less than 8% this year. Unlike in the office and retail sectors, workouts of distressed industrial properties have lagged: Real Capital Analytics reports that only 30% of the distressed industrial properties accumulated since the recession have been worked out. Further, more than $10 billion of industrial properties are currently in distress and must be worked out; about two-thirds of these properties are warehouses. Distressed asset sales accounted for approximately 9% of industrial property sales in the first quarter and 14% in the second quarter of 2011.

SUMMING UP The painfully slow economic recovery of the past two years weakened further during the first half of 2011. While bad weather, supply interruptions, and protracted political debate on extending the U.S. debt ceiling all contributed to the economic slowdown, the root causes of our economic problems are largely unchanged: housing continues to be depressed, unemployment remains above 9%, job growth is slow, consumer spending is weak, and businesses lack confidence to invest and hire.

Adding to the growing concern that we are slipping into a double-dip recession is the deteriorating sovereign debt crisis in Europe—which threatens another global financial crisis—extreme volatility in the equity markets, turmoil in the Middle East, and