Real Estate Quarterly Highlights Second Quarter 2012

Transcription

1 TIAA-CREF Asset Management Real Estate Quarterly Highlights Second Quarter 212 What s Inside Real Estate Investment Quarterly Highlights features overviews of: Real Estate Financial Markets Apartment Market Industrial Market Office Market Retail Market

2 Introduction Outlook for Real Estate Investment Performance Positive Forces include ten consecutive quarters of positive NCREIF- NPI property returns, twelve consecutive quarters of GDP growth, a still expanding labor market, still healthy consumer spending, and support from a low interest rate environment. economic growth in the second quarter weaker than hoped but still positive. Payroll employment gains total 1. million for the year through July with July s 163, gain more than double the second quarter s monthly average. Financial markets tolerating the disappointing economic performance in the second quarter with both equity market performance and credit spreads generally well behaved. Consumer spending hiccups in the second quarter but grew at a 1. rate, slowed mainly by a big drop in spending on trucks and autos. Nonresidential fixed investment and spending on equipment and software increased at a healthy rate in the second quarter, indicative of businesses solid balance sheets and willingness to invest to foster long-term growth. Fed extends Operation Twist to year-end and indicates readiness for additional stimulus. Eurozone muddling through their debt crisis with indications that the European Central Banks will slowly morph into a more effective monetary authority. Central banks are increasingly coordinating efforts to control contagion; The Bank of England and several emerging market central banks have eased fiscal and monetary policy. Negative Forces include tepid growth in the second quarter, a sluggish labor market, persistently high unemployment, the detrimental economic impact of the upcoming fiscal cliff, and the ongoing Eurozone crisis. economic growth was weak at 1. in the second quarter. Second-quarter employment growth averaged only 82, per month; private sector employment growth was marginally better at 12, per month. Unemployment rate holding stubbornly above 8% through July. Fed s remaining conventional fiscal policy tools are limited. The fast-approaching fiscal cliff will dampen growth in the second half of 212 and, if not adequately addressed, push the economy into recession in 213. debt ceiling will need to be negotiated and increased again in 213. Eurozone drama continues with European economic growth expected to be negative for the year as a whole. Slowing growth in China, Brazil and India pose a threat to sustaining the global recovery; a hard landing in China is a possibility and would have significant ramifications. Quarterly Highlights Second Quarter 212 2

3 Conclusions commercial real estate investment performance accelerated in the second quarter and produced a twelve-month total return of 12.. The acceleration in the second quarter reversed the decline in momentum noted in the first quarter. Investor interest remained concentrated on the highest-quality properties in major markets, especially apartments. These solid investment returns occurred in an otherwise dicey economic environment of sagging GDP growth, weakening consumer-spending growth, and ongoing shrinkage in the government sector. The best news in recent months has been the economy s success in muddling through in the face of repeated disappointments, though it is important to recognize that disappointments are more easily tolerated than shocks. It is disappointing that the Congress has been unable to produce agreement on spending and tax policy but rather has kicked the can to the edge of the fiscal cliff. It is disappointing that businesses have been unable to look past their own disappointments with policy uncertainty to produce more solid job growth. It is disappointing that the Eurozone members have been unable to produce agreement on the fiscal coordination required to solve their debt crisis. In the face of these disappointments, both consumer confidence and small business confidence remain below their pre-2 levels, but their volatility has quieted down compared to last summer when the story line was about shocks rather than disappointments. Commercial real estate performance has benefited from this comparative steadiness even in the face of disappointing growth. Property investments are also benefiting from the continuing discipline in new construction that is perhaps also related to disappointing growth. Apartments are the exception where the development pipeline is active. Additionally, commercial real estate has benefited from the sectors of the economy that are doing quite well including tech and professional and business services, along with the ongoing migration of tenants to higherquality space. These sources of return do not appear to be tapped out and can continue to bolster growth even if the path of macro-economic growth continues to disappoint. But, there is evidence that stronger growth might be forthcoming; and that evidence supports economic forecasts showing a return to 3% trend-like growth by the end of next year. An important driver behind that forecast is the continuing slow healing in the housing sector along with an eventual bottoming-out in state and local government cutbacks. Even if these forecasts prove to be disappointing again, property values can hold because disappointing growth will keep Treasury rates very low. Economic and Real Estate Cycles 8% NPI Quarterly Total Returns 6% 4% 2% -2% 2Q % -4% -6% -8% Recession 21 Recession 2 Recession Real Estate Investment Quarterly Highlights: Second Quarter 212 is prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF s Global Real Estate Group as of August 212. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Data is as of 6/3/212 unless noted otherwise. Real estate investing risks include fluctuations in property values, higher expenses or lower income than expected, higher interest rates which affect leveraged investments, and potential environmental problems and liability. TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association (TIAA ). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). 212 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), 73 Third Avenue, New York, NY 17 C62 Quarterly Highlights Second Quarter 212 3

4 Real Estate Performance Overview Total Return Momentum Slows The NCREIF Property Index (NPI) ended the fourquarter period through June 212 with a 12. total return versus 13.4% for the prior period. Income returns were steady at 5.9% versus 6. previously while capital returns fell to 5.9% from 7.1% previously. The moderation in total returns is consistent with the slowdown in the economy and the moderate growth in values following the strong recovery in values during 2. With the economy expected to remain weak in the second half of 212 and real estate fundamentals improving only slowly, further moderation in returns is likely in the quarters ahead. NCREIF Returns for All Property Types Q12 Valuation and Transaction s Inch Down rates implied by NCREIF-NPI property valuations inched down to an average of 5.94% for the four quarters ending June 212 versus 5.97% in the previous four-quarter period, marking the ninth consecutive quarterly decline. Value weighted cap rates inched up to 5.56% from 5.54% previously, suggesting that cap rates for top-tier properties held firm. Nonetheless, both are still 5+ bps above their third-quarter 2 lows. NCREIF transactional cap rates declined to 6.3 versus 6.39% previously. With Year Treasury yields averaging 1.81% in the second quarter, real estate s 45 bps initial return premium to transactional cap rates is attractive. Pricing for All Property Types Rolling 4Q Avg, Except Treasury Qtrly Avgs Growth -Yr Treasury Yr / / / Solid Returns Across Most Markets Each of the 6 NCREIF markets registered positive total returns for the four-quarter period ending June 212. Performance was solid across the country with only modest regional differences, lead by the West at 13.. Major market leaders included San Francisco, Boston, and San Jose. The weakest performance was seen in metros with still challenging economies such as Pittsburgh, St. Louis, and New Haven, CT. NCREIF MSA Dispersion Rolling 4 Quarters Ending /212 CAPITAL APPRECIATION 2 San Francisco Pittsburgh TOTAL RETURN Transaction Activity Increases According to Real ital Analytics, commercial property sales totaled $57 billion in the second quarter, up 12% versus first quarter and up 3% versus second quarter 2 after excluding several large M&A-related sales in 2. Activity was surprisingly strong given the slowdown of the macro economy and deterioration in business sentiment. RCA noted that prices held firm and that cap rate compression continued in the quarter, and particularly in the apartment and retail sectors. RCA Transactions Quarterly Volume Through 2Q 212 $ BILLIONS Quarterly Highlights Second Quarter 212 4

5 Financial Markets Overview Stock Markets Give Back Gains The stock market jitters that emerged in April continued through the second quarter and into July propelled by the combination of weaker economic growth and the continuing Eurozone drama. The Russell 3 ended July 2.8% below its level at the end of the first quarter. In early June, the index traded almost 1 below its first quarter close. European stocks represented by the Morgan Stanley Developed Markets index was not as fortunate, dropping 13% between the end of the first quarter and the end of July. The decline reflects economic deterioration to recession-like performance across both the U.K. and much of the Eurozone. Even the powerhouse German economy is weakening as its exports to Eurozone neighbors suffer. In emerging markets, at the end of July, stocks were 8. below their first-quarter close reflecting the slowdown in growth in China in response to policy tightening. versus Foreign Stocks Data Through 7/ Russell 3 ML-Developed Mkts Blmbrg-Emrg Mkts Mar Jun Sep Dec Credit Spreads Largely Unchanged Credit spreads gyrated in a fairly narrow range between the end of the first quarter and month end July but with little material change at the end of the period. High-yield B-corporates landed at 61 bps at the end of July almost spot on the 596 bps closing on March 31. Investment-grade BBBs landed at 255 bps, up slightly from 243 bps at the end of March, and emerging markets bonds were similarly up to 624 bps from 613 bps at the end of March. This narrow range of movement suggests that credit investors remain confident that neither the fiscal cliff nor the Eurozone debt troubles will precipitate another market crisis in the near term. Credit Spreads Data Through 7/31 ML B ML BBB ML Emerging Mkts Swap * Merrill Lynch Global Indices Option-Adjusted Spreads, except -yr Swap which is a simple spread over the -yr Treasury rate. Mar Jun Sep Dec Treasury s at Historic Lows With no optimistic economic news, the Treasury curve has been edging down since the end of the first quarter. The -year Treasury yield hit a historic low of 1.38% on July 25 and ended the month at 1.47%. The 3-year swooned as well ending July at 2.5. The 2-year closed July at.21% and the 5-year at.58%. Reversal does not appear plausible anytime soon. The FOMC affirmed that federal funds would likely remain at zero through the end of 214 and promised further accommodation if needed. Sixty percent of financial forecasters expect that additional accommodation to come out of the September FOMC meeting. The FOMC s repeated assurances that dry policy powder is available are good for confidence, but this will not be true forever. Treasury s Data Through 7/31 8% 7% 6% 4% 3% 2% 1% Yr Trsy 5Yr Trsy Mar Yr Trsy 3Yr Trsy Jun Sep Dec Quarterly Highlights Second Quarter 212 5

6 Apartment Market Overview Apartment Properties Cede Pole Position Apartment properties recorded the secondhighest total return among the major property types at 13.2% for the four-quarter period ending June 212 as compared to a leading 14.8% return previously. Income returns were steady at 5.4%, but the appreciation component fell to 7.6% from 9. in the prior period. Nonetheless, capital appreciation in the apartment sector was still the highest among the major property types in the second quarter. NCREIF Apartment Returns Q12 Apartment s Largely Steady rates implied in NPI apartment valuations edged down to 5.42% for the four quarters ended June 212 versus 5.44% previously. rates have now declined for nine consecutive quarters, but still remain 6 bps above their third-quarter 2 lows. Market transaction cap rates according to RCA held firm at 6.2% for the fourth consecutive quarter. rates declined slightly for garden apartments, but rose for mid- and high-rise properties as fewer trophy properties changed hands. Apartment registered a robust.6% increase in the quarter, reflective of landlords pricing power. Apartment Property Pricing and Treasury Rolling 4Q Avgs, Except Treasury Qtrly Avg of Daily s Growth -Yr Treasury -Yr / / / Apartment Fundamentals Remain Solid Apartment market fundamentals strengthened further as the national vacancy rate declined to 4.8% in the second quarter 212 as compared to 5.4% in the second quarter 2. (Year over year comparisons are necessary to account for seasonal leasing patterns.) The improvement was broad-based, with vacancy rates declining in 48 of the 63 markets tracked CBRE-EA. Effective rents, which include concessions such as free rent, increased in virtually all markets, and have now surpassed their prerecession peaks nationally. Apartment Vacancy Dispersion CURRENT VACANCY Q12: 4.8% 2Q: 5.4% Current Vacancy Below Current Vacancy Above Markets with rising vacancy Markets with declining vacancy VACANCY YR AGO Construction Heats Up Construction is picking up with a still modest 125, units expected in 212, but the pipeline for 213 and 214 is growing quickly. However, obsolescence of older units and favorable demographic trends will bolster demand. Despite historically low mortgage interest rates, tight lending standards and fears of further home price declines are dampening prospective buyers interest. Opportunistic capital is targeting single-family rentals, and with Fannie completing its sale of 2,5 foreclosed homes and FHA entertaining bids for 9, defaulted mortgages, developments in the single-family market bear watching. Apartment Construction COMPLETION/STOCK EST PROJ Quarterly Highlights Second Quarter 212 6

7 Industrial Market Overview Industrial Sector Moves to Third Place Industrial property moved to third place among the major property sectors from second place previously. Total returns averaged 12.2% for the four-quarter period ending June 212 versus 13.9% for the prior four quarters. Income returns were largely steady at 6.4% for the quarter versus 6. previously. Appreciation returns fell to 5.6% versus 7.1% for the prior four-quarter period. Fundamentals continued their gradual improvement, supported by GDP growth, a 1. increase in industrial production in the second quarter, and still healthy global trade flows. NCREIF Industrial Returns Q12 s Steady; Grows Again Implied cap rates in industrial property valuations were essentially unchanged at 6.% for the four quarters ending June 212 versus 6.3% previously. However, implied cap rates have declined by 3 bps over the past year. Market transaction cap rates according to RCA inched down to 7.7% on average from 7.8% but are significantly lower in top-tier markets. grew modestly for the second consecutive quarter, at 2. versus 2.3% previously. Industrial Property Pricing and Treasury Rolling 4Q Avgs, Except Treasury Qtrly Avg of Daily s Growth -Yr Treasury -Yr / / / Industrial Availability Falls Further The industrial availability rate declined to 13.2% in 2Q12 from 13.4% in the first quarter 212. Availability rates declines were broad based, with 34 of the 58 markets tracked by CBRE-EA showing improvement during the quarter. Several major markets have availability rates below 1 including Los Angeles, Houston, Portland, and Orange County. Nationally, availability rates are still elevated, but despite lackluster economic growth, net absorption has been positive for two straight years. Markets have also benefited from minimal construction. Industrial Vacancy Dispersion CURRENT VACANCY Q12: 13.2% 2Q: 14. Current Vacancy Below Current Vacancy Above Markets with rising vacancy Markets with declining vacancy VACANCY YR AGO Construction Still Moribund With vacancies elevated and rent growth elusive, speculative construction has not been feasible for several years. Though markets are slowly turning the corner, many expiring leases are above-market which will put a further damper on construction over the near term. In the interim, construction will be largely tenant driven in the form of built to suits for companies with specialized needs (e.g., Amazon). Construction is not expected to return to historic averages until Industrial Construction 3. COMPLETION/STOCK EST PROJ Quarterly Highlights Second Quarter 212 7

8 Office Market Overview Office Returns Lag For the second consecutive quarter, office properties were last among the major property sectors with a. total return for the four quarter period ending June 212 versus 12.8% previously. Income returns were largely steady at 5.8% versus 5.9% during the prior four quarter period. Property values increased, but capital appreciation slowed to 4.6% from 6.6% previously. NCREIF Office Returns Q12 s Fall Further; Grows Again Office cap rates implied by NPI valuations fell to 5.89% for the four quarters ended June 212 versus 5.97% in the prior period. Per RCA, transactional volume totaled a healthy $15 billion in the quarter, with cap rates averaging 7., but detailed data show that cap rates are up to 15 bps lower for top properties in top-tier markets. growth was positive for the second straight quarter, growing 1.3% following the first quarter s 2.3% increase. Prior to that, had declined for eight consecutive quarters. Office Property Pricing and Treasury Rolling 4Q Avgs, Except Treasury Qtrly Avg of Daily s Growth -Yr Treasury -Yr / / / Office Fundamentals Continue to Improve Despite subpar employment growth, the national office vacancy rate fell to 15.7% in the second quarter versus 16. in the first. Further, vacancy rates declined in 48 of the 63 markets tracked by CBRE-EA. Nonetheless, tenants remain cautious given the uncertain economic outlook and approaching fiscal cliff. Employment growth in the two primary officeusing sectors, financial services and professional and business services, was positive but weaker than in the first quarter; however, space demand from the tech sector has been robust. Office Vacancy Dispersion CURRENT VACANCY Q12: 15.7% 2Q: 16.2% Current Vacancy Below Current Vacancy Above Markets with rising vacancy Markets with declining vacancy VACANCY YR AGO Office Pipeline Remains Tame With its long lead time, office construction has historically been both lumpy and highly cyclical. As with the industrial sector, office rents remain well below the levels needed to justify new construction. In the interim, the lack of large blocks of contiguous space in major markets and the technological obsolescence of older buildings will be the primary factors driving new construction. However, construction is expected to remain modest to Office Construction 4% COMPLETION/STOCK 3% 2% 1% EST PROJ Quarterly Highlights Second Quarter 212 8

9 Retail Market Overview Retail Property in First Position Retail property leapfrogged into first place among the major property types from third place previously. Total returns averaged 13.4% for the four-quarter period ending June 212 versus 12.9% previously. Further, retail was the only property type to see returns increase during the second quarter. Income returns were largely unchanged at 6.4% versus 6. previously. ital returns increased to 6.7% versus 6.1% previously. NCREIF Retail Returns Q12 Retail s Hold Steady Retail cap rates as implied by NPI property valuations averaged 6.5 for the four-quarter period ending June 212 compared to 6.5 for the prior period. According to RCA, market cap rates averaged 7.2%, with retail cap rates falling at a faster rate than for other property types. Sales activity was solid across all center types, with strip center sales up 26% YOY excluding 2 s Centro transaction. growth was positive for the eighth consecutive quarter, up 2.8%. Retail Property Pricing and Treasury Rolling 4Q Avgs, Except Treasury Qtrly Avg of Daily s Growth -Yr Treasury -Yr / / / Retail Fundamentals Still Soft but Improving Availability rates in neighborhood and community centers inched down to 13. in the second quarter 212 versus 13.1% in the first quarter 212. Retail sales were weak in the second quarter, dropping a modest.3% versus the first quarter 212 but up 4. versus the second quarter 2. Still, retailers remain cautious about opening new stores given the uncertain economic outlook. Nonetheless, there are signs of improvement with national inline tenants reporting solid same-store sales growth and strip center REITs reporting stronger than expected leasing activity and modest rent growth in the second quarter. Retail Vacancy Dispersion CURRENT VACANCY Q12: 13. 2Q: 13.2% Current Vacancy Below Current Vacancy Above Markets with rising vacancy Markets with declining vacancy VACANCY YR AGO Retail Construction Mired at Historic Lows Neighborhood and community center construction, which totaled less than msf in 2 and 2, is on pace to fall below 5 msf in 212. Subsequent years will move higher but only modestly so, with construction remaining significantly below historic norms through A lack of construction coupled with modest growth in consumer spending should contribute to slow and steady improvement in retail market fundamentals over the near term. Retail Construction 3. COMPLETION/STOCK EST PROJ Quarterly Highlights Second Quarter 212 9