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Wednesday, December 12, 2012

Real Estate’s Correlation to Bonds

By: Amy Erixon (Toronto)

Last week the annual Canadian Real Estate Forum was held in Toronto.   The topics from two of my recent blogs were widely discussed:  1) soft or hard landing for the topping condo market, and 2) the relationship of commercial real estate pricing and interest rates.   
My April, 2011 blog documented the fact that over the past 50 years in the US commercial property market, interest rate changes affect who buys, (leveraged buyers enjoy a temporary cost of capital advantage) but have not had a strong influence on actual property pricing.  Perhaps this is because interest rates are traditionally lowered when economic prospects are poor.   Logic follows that a weak economy should lower property values as underwritings become more conservative in terms of rollovers, rent growth, costs and vacancy allowances.   We are recently observing a period where, since 2001, interest rates have been very low, and generally declining, and so have cap rates.  Globally, this created an atmosphere of increasing use of leverage on investments to maintain net returns near historical averages.  Interest rates are currently at unprecedented low levels to support anemic economic growth.    Meanwhile, residential and commercial property prices, which in Canada did not correct much in 2008 and 2009, are simply going higher and higher.   The consensus of Toronto conference participants was that property prices will continue to go higher until rising interest rates bring them down.  Given the amount of new capital being allocated to real estate these days, I am not convinced that within reason, higher interest rates will not have an immediate or direct manifestation into lower prices, there are a lot of factors to consider. 
To justify that real estate pricing is not in a bubble, many point to the spread between real estate cap rates and treasuries (or Government of Canada Bonds).  We will unpack this in a moment, but recently key industry leaders have begun to assert that property is, in fact, being priced off the bond market, and that their clients think it should be.   This is nonsense.   Investors still use long term models to acquire real estate.  Mortgages may be priced off the bond market.  But, the key attributes that investors seek from property investments in a multi-asset class portfolio are a low correlation to stocks and bonds, and a long term inflation hedge, neither of which would be served using this benchmark. 
A better understanding of current market conditions is that many asset classes are moving in sync and this is not what we would usually see (think gold and stocks in 2011).  Allocations investors make to various asset classes are influenced by relative risk and return expectations, diversification goals and other considerations, such as indexing of benefits.  Market pricing is a result of supply and demand for assets, which draws from a broad array of factors.   A lot of what we have been seeing is really a flight to quality, and defensive investing, across all asset classes.  Any value manager can tell you a much better indicator of absolute pricing for real estate than bond yields is discount or premium to replacement cost.  I am surprised to hear managers suggest their positive portfolio performance is simply a result of quantitative easing and will quickly be erased when that easing is withdrawn.   We all want to think that our good work, supply discipline, stock selection and asset management skills matter more. 
What in fact has been happening is far more complex than a snapshot look at the spread to government bonds.  Investor demand for property is rising.  Real estate has been producing relatively stable income characteristics, even in countries where valuations have swung violently over the past 5 years.   Corporate and individual user preferences are shifting.   Energy efficiency, transit oriented locations and mixed use developments are growing in appeal, and prices are being bid up for these kinds of investments.  Beyond a defensive flight to quality (which is also happening), rents in state-of-the-art well located assets are pulling away from those in older stock with bloated operating costs and functional obsolescence.  These shifts are translating into weaker demand and lower pricing for generic assets at the fringes of markets and rising prices for best in class assets.   On average prices may have not increased as much as it might appear due to the prominence of headlines announcing new pricing records in gateway markets throughout the world.  
Defensive investors have been loading up on property company stocks, REITs and where they can, direct investments, including condominiums as rental properties.  Cheap and available mortgages are allowing investors broad access to property markets in scale.   This surge in debt and equity capital is driving up prices, particularly for best in class assets.  In Canada much of this allocation shift is coming out of the bond market where returns are far below actuarial requirements, and credit quality has deteriorated.   I believe that people are confusing rising prices resulting from rising demand for income products with leverage fueled asset price expansion, although we may be seeing some effect from both.      
There is no question however, that the housing market is highly sensitive to interest rate shifts.   A glance at the chill created in Canadian markets by simply changing allowed amortization lengths underscores this.   This may magnify our impressions of the impact leverage is having, as most of us are homeowners, and it affects us directly in the pocketbook.  The longer these very low rates stay in effect, the more “baked-in” to the economy they become, and the more difficult they will be to increase, especially for housing. 
The real question for us to be asking is how sticky is the current allocation surge toward property?  Does this constitute a rethinking by the market of the fundamental value proposition offered by traditional asset classes, such as stocks and bonds, and does such a shift have staying power?

Wednesday, December 5, 2012

Energy Fuels Houston's Real Estate Market

By:   Rand Stephens and Jeannie Roberts

Houston gained national attention in 2012 due to its economic vitality and strong job growth.  Driven by the oil and gas industry, Houston left the recession behind and turned its attention towards expansion, development, and acquisition.  Construction activity has substantially increased as developers address the pent up demand brought on by the economic downturn.  While Houston continues to stand out due to its economic environment, in 2012 the city also gained recognition as a desirable place to live.  Forbes ranked Houston as the Coolest City in America due to its cultural diversity and young workforce.  The International Energy Agency projects that the U.S. will overtake Saudi Arabia as the world’s top oil producer, and Houston is poised to take advantage of the oil boom in 2013 and beyond.  This will result in continued job creation and strong market fundamentals in the Energy Capital of the World.
Leasing activity in Houston’s office market picked up in 2012 with the continued expansion in the energy sector.  With rental rates on an upward trend and vacancy rates reaching the single digits in key submarkets, developers were quick to regain their pre-recession bullish approach.  3.9 million square feet (msf) of office space is under construction, with 3.1 msf delivering by the end of 2013.  45% of the construction is taking place in West Houston where the energy industry is concentrated.  The demand for new development is largely driven by tenants moving out of older buildings in an effort to retain a talented workforce and consolidate into efficient space.  A number of mergers and acquisitions within the energy industry are projected to occur in 2013.  Although this creates uncertainty in the office market, Houston will most likely benefit as most companies are expected to consolidate within Houston.
The industrial market witnessed significant space gains during 2012.  Strong demand and moderate development have led to a tightening industrial market, a trend that is likely to persist throughout 2013.  In an effort to find quality land, developers are expanding further north and west.  As drilling activity picks up, Houston’s industrial market can expect to see an increase in manufacturing volume, particularly in oil field equipment.  In anticipation of the Panama Canal expansion in 2014, the Port of Houston is making $206 million in capital improvements this year.  The industrial market is projected to benefit from this increased activity, resulting in increasing rental rates and decreasing vacancy through 2013. 
The retail market accounts for roughly $165 billion of Houston’s gross metropolitan product.  While retail jobs in most major metro areas have yet to recover, Texas created 24,500 retail jobs between August 2011 and August 2012.  Houston’s growing population is fueling the retail market, resulting in new development, particularly in West Houston.  Vacancy in the retail market is expected to decrease in 2013 as tenants capitalize on the renewed consumer confidence.
Driven by the energy industry, Houston has long been characterized by its boom and bust cycles.  However, the city’s focus on diversification in the past decade has led to a stable and growing economy.  Investors, both foreign and domestic, demonstrated their renewed confidence in Houston with record-breaking transactions in 2011 and 2012.  The Hess Tower sold for a record $524 per square foot in 2011, while the Shell Plaza Towers sold for a record $550 million in 2012.   High-profile assets, such as the Williams Tower and the Kinder Morgan building, have returned to the market in 2012.  As Houston continues to stand out among other major metropolitan areas, the city is projected to gain increasing amounts of investor interest.

Monday, December 3, 2012

Virginia Incentive and Assistance Programs for Startups and Business Expansion

By Dan Gonzalez (Washington DC Metro)

To support a pro-business environment, Virginia offers many incentives to startups and to assist in business growth. These incentives include financial assistance, facilities development grants, tax credits, and exemptions.
In particular, The Virginia Jobs Investment Program (VJIP) is one of Virginia's most actively used and popular economic development incentives. The program encourages the expansion of existing businesses and startups in finding and developing skilled workforces.  It also helps offset recruiting and training costs incurred by companies that are either creating new jobs or implementing technological upgrades. 

In addition, Virginia law currently provides a 100 percent capital gains tax exclusion for founders of, and investors in, high technology start-up companies located in Virginia.
According the the Virginia Economic Development Partnership (, the following are state programs offering incentives and assistance to startups and expanding firms: 

Virginia Investment Partnership Act

The Virginia Investment Partnership (VIP) Grant and the Major Eligible Employer Grant (MEE) are discretionary performance incentives designed to encourage continued capital investment by Virginia companies, resulting in added capacity, modernization, increased productivity, or the creation, development and utilization of advanced technology.

Virginia Small Business Financing Authority (VSBFA)

VSBFA offers programs to provide businesses with access to capital needed for growth and expansion.
Enterprise Zones

Virginia's Enterprise Zone program provides state and local incentives to businesses that invest and create jobs within Virginia's enterprise zones, which are located throughout the state.

Technology Zones

Virginia authorizes its communities to establish technology zones to encourage growth in targeted industries. Presently, 27 cities and counties and 3 towns have created zones throughout the state.

Center for Innovative Technology
CIT helps grow Virginia’s technology industry. Its CIT Entrepreneur program provides up to $100,000 in funding for promising high-growth technology companies and helps owners identify potential equity investors.”

Thursday, October 25, 2012

Fourth Quarter 2012 North American Market Update

By Mark E. Rose (Toronto)

With summer now well behind us, please find below Avison Young’s summary overview of Q4 market conditions in North America.
In the U.S., all eyes and ears have turned to the looming presidential election and the “fiscal cliff,” and in Canada, astonishingly, to rising consumer debt levels. These factors, coupled with the on-going debt crisis in Europe and the potential slowdown in China, are undoubtedly altering business operations, which have and will temper real estate decisions affecting the leasing and investment markets.
As I will discuss, there are trends in the sector that directly impact how positive or negative our markets will be. On the one hand, the lowest interest rates in recent history have put a floor underneath fundamentals and valuations. On the other hand, there is nowhere to go but up for interest rates. Despite this cheap capital, the U.S. has not seen significant increases in transaction velocity and continues to bounce along a cyclical trough.
Canada has used its stable banking system and financial strength to weather the storm and provide liquidity, which has led to a recovery in investment activity and pricing that is meeting or exceeding 2007 levels.
 Said differently, North American investment opportunities most likely shift to the U.S., which is bottoming, and away from Canada where risk is inherent and pricing is most likely at a near-term top.
As always, we communicate with clients to advise and provide solutions, and when we believe there is a need for them to review and adjust their investment strategies.
So let’s move to the details:
The labour market is a key barometer for us and something we watch carefully, especially with rising consumer-debt levels and the potential rise in interest rates, and the impact they may have.
Following strong gains in the spring, and a lull in the summer, Canada put together two solid months of job creation to end the third quarter of 2012 on a positive note. In all, 52,000 positions were created, mainly in full-time work. However, the unemployment rate increased 10 basis points from the previous month to 7.4% as more people participated in the labour market.
The headline number of 52,100 jobs in September puts Canada on much more solid footing than most of its peers. Compared with 12 months earlier, employment is up 1% or 175,000, driven by an increase of 157,000 (+1.1%) in full-time work.
Now on to the real estate markets….
Apart from some soft patches here and there, we are not reporting any material slowdown in the commercial real estate sector in Canada. The market, for now, remains healthy.
While leasing velocity has been steady to date (which is not entirely surprising given the sound fundamentals), we are surprised at the amount of real estate that continues to change hands. Though we haven’t finalized third quarter figures yet, the first half of the year has been very good for Canada, with almost every market reporting higher investment dollar volumes over the same period one year ago.
Nearly $12 billion in commercial real estate assets changed hands in the first half of 2012 – up 26% compared with the first half of 2011. While the investor profile is varied, REITs remain very active, often competing and outbidding pension funds and life companies for some of the most prized assets in the country.
Given the current deal pipeline, continued sound underlying market fundamentals, and barring any deals being pushed into next year, 2012’s investment volumes may very well match, if not exceed, the previous peak of $24 billion in 2007 – so stay tuned!
As I mentioned earlier, this could be the sign of a near-term top in the markets.
Now let’s look at the U.S….

The typical summer slowdown coupled with the upcoming presidential election and lingering economic woes translated into a loss of momentum and lackluster performance for many of the U.S. commercial real estate markets. 

In mid-October, the Bureau of Labor Statistics released its regional and state unemployment summary and reported a national unemployment rate for September of 7.8%, 1.2 percentage points lower than in September 2011. Unemployment is down, but we are not yet feeling the positive impact of job growth.
In 2012, employment growth has averaged 146,000 per month, compared with an average monthly gain of 153,000 in 2011.
The largest year-over-year job increases occurred in Texas (+262,700 jobs), followed by California (+262,000 jobs) and New York (+125,000 jobs.) Not surprisingly, these are major real estate markets that are doing quite well on a relative basis
The 10-billion-square-foot U.S. office market stalled in the third quarter of 2012, with the 12.1% vacancy rate unchanged from the previous quarter, and down slightly from the year-end 2011 rate of 12.3%.  
On a positive note, office construction remains constrained, and the volume of new buildings being delivered has remained well below the historical average since 2009.
The 20.6-billion-square-foot industrial market showed further improvement during third quarter, ending with a 9.1% vacancy rate -- and, as with office, development remains well below historical levels.
The U.S. also continues to attract foreign investment. As of October, Canadian investors dominated, with investments in the U.S. totaling $3.5 billion.
Illustrating how unevenly markets in the U.S. are performing, here are some highlights from select Avison Young major office markets:

A negative trend ― Washington, DC, one of the country’s safe havens of investment and strong commercial real estate fundamentals, felt the slowdown with sales volume and leasing velocity both lower so far in 2012.

A positive trend ― In Chicago’s 1.1-billion-square-foot industrial market, 2.3 million square feet of construction is underway ― including speculative construction! 

A neutral trend ―  In Manhattan, the office market showed little movement through the third quarter as vacancy rates were stable and overall absorption was relatively flat.

If the U.S. resolves the fiscal cliff by the end of the year and a pro-business attitude is adopted out of Washington, the possibilities and opportunities for recovery and growth are exciting. And given the size of the U.S. market, any positive momentum in U.S. capital flows would have an equally positive impact on Canadian and European capital flows.

Until then, and despite the safe-haven status of the U.S., most clients will still be worried about investing in an uncertain U.S. environment and, hence, will continue to gravitate to core products in core markets throughout the U.S. and Canada… and....... will have their fingers firmly on the pause button.
Please also view our inaugural Fall 2012 Canada U.S. Commercial Real Estate Investment Review on our website at

You can also listen to this Q4 2012 Audiocast Message on our website at 

Tuesday, October 23, 2012

Election Scenarios and Effects on the Economy

By Dan Gonzalez (Washington DC Metro)

 With the U.S. Presidential election right around the corner, I thought I’d share “what if” predictions regarding the election and effects on the economy made by the Principal Global Economic Committee.  The group highlighted three election eventualities and the impact on various economic issues (including the much discussed “fiscal cliff ):  1) Romney wins and Republicans retain control of the House of Representatives; 2) Obama wins and the House goes Democrat; and 3) Obama wins and the House stays Republican. 
Romney wins and the House stays Republican:

The group says, “We would expect taxes to be reduced and entitlement spending cut...and the Bush Tax Cuts extended.  With a resolution to the uncertainty that is hindering economic growth, we would expect to see a resumption of growth in the second half of 2013.”
Obama wins and the House goes Democrat:

 “In this scenario,” the group says, “we expect taxes to go up and entitlement spending would either increase or at least be maintained at current levels.  The Bush tax cuts would probably be maintained.  Even though this path looks different than the scenario above, we would again expect the reduced uncertainty would mean growth in the second half of 2013.”

Obama wins and House stays Republican:

 The group notes that “this option brings the highest chance for a downside scenario...with a continuation of the current dysfunctional dynamic.  Any solution (to avoid the Fiscal Cliff) would require concessions from both sides and would likely only be short term “punts,”..and another temporary fix may not engender much confidence.”  Their absolute worst case is that the economy slides back into recession in 2013.

We will know soon enough --- November 6 --- which scenario will occur.  We certainly live in interesting times. 

Monday, October 8, 2012

The Case for Multi-Family

By Rand Stephens, Houston

The US multi-family market is outstanding.   As of 3Q 2012, the nationwide occupancy rate stood at 94.5% with annual rental rate growth of 3.5%.  Areas with good job growth, like Texas, are seeing rental rate growth north of 5%. 

What’s driving these fundamentals and will they continue?

It starts with a look at the US housing market.  Karl Case, who co-founded the Case-Shiller Index, regarded as the key index for tracking the US housing market, was quoted earlier this year regarding home ownership that “the American Dream is gone”.  However, July’s numbers for housing were better than forecasted and have spurred speculation that the US housing market is on the road to recovery.  But Robert Shiller, the other co-founder of the Index warns that despite the uptick in July’s numbers; there is “no unambiguous sign of a strong recovery in the housing market”. 

It’s hard to imagine real legs to a recovery in the housing market with the current state of anemic job and wage growth in the US.  In fact, Karl Case also points out that there are approximately one million new households formed per year in the US and over the last seven years roughly six million of those households are renting instead of owning their home.

This trend of renting was obviously underway prior to the bust of the mortgage bubble and the collapse of housing values.  In 2005, people were already having trouble affording the run-up in housing prices and began renting as an alternative to owning. 

The trend to rent will continue as the affordability issue for most potential homeowners will continue as there’s no clear path to a better jobs market and mortgage underwriting criteria has tightened dramatically.  In addition, the labor force needs to be mobile, and home ownership can reduce the flexibility needed by the workforce to move around the globe to apply their skills. 

Needless to say, lots of people find home ownership to be overrated, and the trend to rent will continue.  Marry-up this trend with a lack of construction financing for new multi-family projects, and the market fundamentals will continue to be excellent. 

Monday, September 24, 2012

Canadian and US Residential Markets: A Study in Contrast

By Amy Erixon, TORONTO

Hardly a week goes by without a dozen articles expressing divergent views on Canadian residential construction levels, prices and prospects.   Home ownership levels are now higher in Canada than in the United States (70% versus 65.4%), despite prices more than three times as high on average.   Will the shoe drop in Canada, like it did in the US?  Will the US ownership market turn around?  And if-so, when?  A current snapshot reveals there is a condo boom going on in Canada, and an equally vibrant apartment investment renaissance in the USA.   How long will these last?

Eventually, all things being equal, prices revert to the mean.   However, all things are not equal. There is a lot of intervention occurring, directly and indirectly in residential and financial markets in both countries, with profoundly different results.  It’s instructive to look at the differences in governmental policy, the role of investor confidence, and capital availability for insights.   In the end, market timing likely hinges on investor confidence; which is increasingly tied to governmental policy.   Interest rates will stay low for some time, oversupply is getting absorbed, and liquidity is ample.  Governments are getting these pieces of the equation right if the goal is improving real estate markets.   Real estate is enjoying improved image relative to other investment alternatives, but frankly other choices these days are pretty unattractive, and that’s not likely to change very quickly either.  How long will confidence hold, and whether very low interest rates cause a second asset bubble - are important questions for a later blog.  Let’s start with assessment of current conditions and the impact of public policy on respective markets. 

Issues from cursory view of Canada:

  • Prices are very high and at record multiples to median income
  • Massive amount of new condo construction
  • Increasing percentage of units being acquired by investors and foreigners
  • Numerous non-traditional players jumping in the game

Factors that are the same in the US and Canada:

  • Shortage of attractively priced investment alternatives with underwrite-able risk
  • Government agencies subsidizing credit flowing to the housing sector, with different approaches being utilized in Canada and the US
  • Record low interest rates which if raised could squeeze both owners and buyers
  • Gateway markets seeing inflows of international “fear and flight” money
  • Rising unit prices/values, and a gap between existing prices and cost of new construction

Differences in Canadian vs US Government Housing Policies relevant to the market:

  • High land values and rent control in Canada means virtually no purpose-built apartments, creating a natural demand for rental of investor-owned condominiums. 
  • No sub-prime lending or personal residence mortgage interest deductions in Canada
  • Canadian government actively trying to cool speculative activity and both supply and demand
  • US Government is actively trying to move assets off its balance sheet and into the market

With higher income security in Canada and more disposable income to allocate to housing, (due in large part to do with differentials in public funding for health care, university education, public schools and social security) ownership is preferred.  But the differential in pricing between the US and Canada is likely unsustainable given the similar economic profile of the residents of each country.  To deal with the rising prices in Canada the market has been shifting away from single family toward smaller, less costly multi-family unit mix.  These units represent an easy entry, attractive investment property option for domestic and foreign individuals, as well as attractive homes for young people entering the market and empty nesters.  Most projects are located in urban centers and amenity rich locations.  So long as supply does not grossly outpace demand, this segment of the market should hold its own.    If demand lets up, the sector could see significant oversupply.

The US market has likely overcorrected.  While showing signs of recovery, it remains in serious oversupply.  The lower confidence levels are manifesting in surging ranks of renters.  Apartment REITs in the US are outperforming other sectors.  The surge in demand has been so strong that in the past 6 months 2 Canadian REITs have been IPO’d and numerous funds and clubs whose strategy is acquisition of US apartments have been formed - including our own product which launched in May of this year. 

Net/net, future market prospects largely come down to buyer and seller confidence holding or improving.  If confidence sags, there is a chance of significant dislocation in Canada, and reversal of current recovery trends in the US.  If it holds, we will enjoy a good run.   

Friday, September 21, 2012

“Big Data” and the Federal Government

by Dan Gonzalez

This is the second installment on the high tech trend of “big data analytics” and its impact on the Northern Virginia data center market.  The focus this time will be on the federal government’s role in creating and deciphering “big data.”  
As noted previously, not all data centers are capable of handling big data users as there are special requirements for handling the one-megawatt-plus users.  Big data centers require mega-storage, higher power, and cooling densities.  Currently, only Virginia, Texas, and California have data centers large enough to handle the big data volume.

Significantly for Northern Virginia, six federal agencies recently teamed up on a $200 million investment to access, organize, and understand the huge volumes of digital data being generated. The agencies involved are:

     National Institutes of Health
     Department of Energy
     National Science Foundation
     Department of Defense
     U.S. Geological Survey

This commitment on the part of these agencies will benefit Northern Virginia in terms of public/private partnerships and major investments in data center facilities and technology.  The driver behind this investment and cooperative was the President's Council of Advisors on Science and Technology.  Its stated goals for the initiative are to:
·         “Advance state-of-the-art core technologies needed to collect, store, preserve, manage, analyze, and share huge quantities of data;
·         Harness these technologies to accelerate the pace of discovery in science and engineering, strengthen our national security, and transform teaching and learning; and
·         Expand the workforce needed to develop and use Big Data technologies.”

Tuesday, September 18, 2012

The Story Behind Cap Rates

By Rand Stephens (Houston)

Short for capitalization rate, a "cap rate" is the unlevered annual cash-on-cash yield of a real estate investment.  Divide an investment property’s annual net operating income (“NOI”) by the asset value, and you have the annual yield assuming an all-cash investment.

The difference between cap rates and the 10-year Treasury (“Spread”) is supposed to represent the risk premium of owning real estate versus the 10-year Treasury, which has traditionally been thought to be the least risky comparable investment since it’s backed by the credit of the U.S. government.

Cap Rates vary based on asset class (office, industrial, retail, multi-family, etc.), and the Spread, when looked at over time, provides investors a perspective on current valuations compared to other time periods.  This analysis is similar to how investors look at historical price/earnings multiples for stocks to get a feel for whether the overall market is underpriced or overpriced.

Since most investors use debt to acquire investment property, they are underwriting the investment on a levered basis using an internal rate of return investment analysis.  With debt involved in the equation, a real estate investment takes on considerably more risk than owning a property with no debt, and using a cap rate when a property is levered as a barometer for reflecting a risk-adjusted return compared to the 10-year Treasury, is not particularly relevant.

In addition, investors use cap rates in their underwriting analysis like a comparable, to check a sales price or valuation of a property, compared to other simlar transactions.  Cap rates are also used in an investment analysis as a way to calculate a terminal value at the end of the projected investment period.

Spreads have been increasing, which means as the Spread moves back into a more historical norm, otherwise referred to as "cap rate compression", property values will go up the  same way bond values go up when interest rates come down.   

With Spreads at historical highs, investment real estate looks like a very attractive asset class.

Saturday, September 8, 2012

Houston - Are we at a Market Top?

By Rand Stephens (Houston)

The answer lies in how you feel about the energy industry.  If you think oil is going to $200 then Houston is poised to explode.  If you believe oil is going to $65, then Houston's economic growth will soften from the 3+% annual growth that we've been enjoying.

Over the last 30 years the evidence is overwhelming that the Houston economy is all about energy as   prices, rig count, job growth, real estate occupancy and rental rates all move in unison.

Since the health of any commercial real estate market is linked directly to job gowth, it's not surprising that Houston's real estate markets are very healthy as this city is rockin' and rollin'!  The collapse of the capital markets have also helped  Houston's real estate fundamentals...Say what?..because there's been no new development coupled with a high demand for space. 

I've spent most of my professional career in the Houston real estate business...lived through our train wreck of the 80's, as well as several other ups and downs.  Houston's real estate fundamentals are the best I've ever seen!

Tuesday, July 31, 2012

Third Quarter 2012 North American Market Update

by Mark E. Rose (Toronto)

As August approaches and the summer seems to be slipping away, please find below Avison Young's summary overview of Q3 market conditions in North America.

Let’s start with the United States….

In July, the Bureau of Labor Statistics reported a national unemployment rate of 8.2% in June, unchanged from May, but down from 9.1% a year earlier.

Slower job growth in the second quarter occurred in most major industries; however, the Professional and Business Services sector added 47,000 jobs in June -- with temporary help services accounting for 25,000 of the increase.

Employment in Professional and Business Services has added 1.5 million jobs since its most recent low point in September 2009.

With office construction generally slow across the U.S., the 10 billion square foot U.S. office market continued its slow but gradual improvement and ended the second quarter with an average overall vacancy rate of 12.1%.

Improvement has been uneven however, with a handful of markets seeing the greatest gains.

Here are some highlights from select Avison Young office markets:

Indicators were mixed for the Manhattan office market as the second quarter drew to a close.  Leasing activity rebounded from record-low levels in the first quarter, yet the vacancy rate rose to 10.8%, while absorption finished in negative territory. We expect, however, that tenants will be back in the market in the fall to lock in rates before the market moves out of their favor.

In Boston, with no speculative construction and growing high-tech and biotech sectors, one can expect to see further improvement.

In Chicago, the office market vacancy rate improved to 14% from nearly 16% a year ago, with the market seeing leasing activity from several significant occupiers in the CBD.

Houston is benefiting from the expanding energy sector and ended the second quarter with an 11.4% vacancy rate.  Class A vacancy in some key submarkets is now in the single digits. 

Pittsburgh’s metropolitan area has a vacancy rate under 10%, the lowest of the Avison Young markets as of mid-year.

In metropolitan Washington, D.C., more than 7 million square feet is under construction with approximately 50% preleased. 
According to Real Capital Analytics, sales volume in the U.S. for all property types and markets was approximately $84 billion through May, with the metro areas of New York, Washington, DC, Los Angeles, San Francisco and Chicago comprising the top five markets.
Canadian investors have purchased more than 100 properties for a total volume of nearly $4.7 billion thus far in 2012, and seem to be on-track to reach 2011’s total of 235 properties for $8.2 billion.
Overall office market fundamentals improved by mid-year. However, the upcoming presidential election and instability abroad is fueling uncertainty.

Now let’s look at Canada….

As we turn to the second half of 2012, Canada’s commercial real estate markets remain robust and on a stable footing, in spite of negative economic news streaming in from the Euro-zone, the general economic malaise in the U.S. and civil unrest in places such as Syria.
The labour market and business confidence are two key metrics that we continue to watch carefully. 
On the labour front, employment changed little for the second consecutive month.
The unemployment rate edged down 10 basis points to finish the midway point of 2012 at 7.2.
Compared with 12 months earlier, employment increased 1% or 181,000. At the same time, full-time work was up 222,000 (+1.6%), while part-time work changed little. More importantly, employment growth over the previous 12 months was mostly among private sector employees, up 149,000 (+1.3%).
Although business confidence has waned of late, dictated largely by headlines abroad and the potential impact at home, most corporations sport positive balance sheets and are flush with cash, ready to expand their operations. This is evidenced by the single-digit office vacancy rates displayed by most of Canada’s major markets.
At the end of June, Canada’s office vacancy rate sat just above 7% and is down some 70 bps from the same period one year ago, and down 280 bps from the height of the recession in June 2009. 
Downtown markets are especially tight, collectively exhibiting a vacancy rate just above 5%.
This has spurred on a new development cycle in most downtown markets. Almost 11 million square feet of additional product has been announced or is under construction, with Calgary and Toronto accounting for just over 70% of the development activity.
With sound leasing fundamentals and rising rents, the buying and selling of commercial real estate assets has not abated. The drop in long-term interest rates has been greater than we could have anticipated and has led to still lower cap rates and higher real estate values across markets and asset types.
The highlight for the second quarter and for 2012 was the sale of Scotia Plaza – the 2-million square-foot office complex located in the heart of Toronto’s Financial Core. Despite all the rumors and speculation, two of Canada’s largest REITs, Dundee (66%) and H&R (33%) bought the coveted complex for a record $1.266 billion -- the highest price ever paid for a single commercial real estate asset in Canada.
While hard assets continue to change hands, REITs/corps have issued or announced $4.6 billion in capital raisings through the midway point of July – up from $2.8 billion over the same period one year prior – a clear signal that investors view real estate as a stable investment vehicle, versus the roller coaster ride of the stock market.  
Looking ahead to the second half of 2012, we don’t expect any dramatic change in market conditions other than the traditional slowdown in leasing activity attributed to the delay in decision-making associated with the summer months.
You can now listen to our Q3 2012 Audiocast Message on our website (link on home page and also under Media Room):   

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