"All the stars are aligned for a pretty big year for U.S. commercial property in 2011," says Dan Fasulo, managing director at Real Capital Analytics, a New York-based commercial real estate consulting firm.
Fasulo and other market observers expect economic improvement, which historically has helped the commercial real estate industry. The recovery might be slow and unsteady, but many analysts believe the U.S. will avoid a double-dip recession. If the worst is over, "it will bode well for capital looking to make long-term commitments to this asset class," Fasulo asserts.
Recent data support an improvement in commercial real estate prices. About half the decline in property values that occurred between 2007 and 2009 has been erased, according to Newport Beach, Calif., research firm Green Street Advisors. The company says its Commercial Property Price Index, which measures unleveraged U.S. commercial property values, rose by 2% in November.
"We have a reasonable outlook for commercial real estate, but the economy will be the driving force," says Paul Adornato, an analyst with BMO Capital Markets, a diversified financial-services provider.
Jones Lang LaSalle, the country's second-largest publicly traded commercial property broker, estimates total U.S. commercial property transactions in the apartment, office, retail and industrial sectors will increase by up to 40% in 2011.
But the recovery in commercial real estate values has been, and is likely to remain, uneven. Analysts say the market has bifurcated, with transactions concentrated in both the upper and lower segments. The market is now divided into one group of core-income-producing assets in major markets that have recovered nicely and another group of troubled assets in secondary markets that continue to struggle.
Fasulo describes these distressed assets as "properties that need capital, or busted condominium projects or development sites." This bucket of properties is closely linked to local markets and the general economy. It's the segment of the market that hasn't yet seen a significant recovery in 2010, and is not likely to in 2011.
Still, analysts believe operating fundamentals are stabilizing. Vacancies for apartments, offices and regional malls are no longer rising significantly and rents in the downtown markets of major international cities such as New York, San Francisco and Washington, D.C., are beginning to increase.
Fasulo likes the outlook for commercial real estate in 2011 for these reasons and others. Between the low yields on government bonds, the high prices of corporate bonds and the volatility in the stock market, he thinks "the attractiveness of having a hard asset that provides income, i.e., commercial property, will continue to attract capital to the sector in the near future."
REITs should perform decently in 2011 because many are well-capitalized and positioned to vacuum up desirable properties at good discounts. They'll be able to take trophy buildings and high-end shopping malls from financially strapped competitors, such as highly leveraged private equity funds, according to Brad Case, vice president, research and industry information at the National Association of Real Estate Investment Trusts (NAREIT). "Publicly traded REITs have access to capital. Other owners of commercial properties are in big trouble. When default rates go up, that means an increase in the number of distressed sellers whose properties may become acquisition targets for REITs," Case predicts. "Longer term, the factors that are going to drive REIT earnings are improved fundamentals and the opportunity to acquire assets."