Global Viewpoints

Survey Shows Investor Apathy

The latest global commercial property survey from the Royal Institution of Chartered Surveyors (RICS) shows investment activity continued its downward spiral in all regions except for Latin America. The weakest investment markets were seen in North America, Australasia and Western Europe.

Of the more than 50 countries surveyed, seven of the 10 worst performing countries are located in Western Europe with the most negative sentiment towards prices for the third quarter expected in the Republic of Ireland and Spain. Hungary, New Zealand and South Africa were also found in the bottom 10 with the U.S. only one place above the bottom 10.

Office and retail rental prices experienced negative growth for developed Asia while Middle East recorded the highest percentage growth in the past three months. The same trend prevails for capital values of office and retail properties in both Developed Asia and Middle East.

Among 10 countries in Asia, including Singapore, Japan and Korea, Hong Kong is the only city with positive investment bidder demand, while all the other regions reported negative demand in the second quarter. Looking in investment yields, Hong Kong ranked the third among the 10 regions with New Zealand ranking No. 1 and Japan ranking No. 2 in the same category.

A rise in yields was recorded in emerging markets for the first time in the survey's history as aggressive inflation fighting in some emerging market locations has impacted upon commercial property pricing.

Retail Tenants Push Back and Owners Dig In

By Barry Tuman

In the UK recently there was a surprising property related discussion being aired openly in the business press.

It is a reaction to both historically high retail market rental rates, which were caused by significant increases over the last seven years, and the current liquidity crunch impacting industries beyond pure property companies, including large retailers who fill a significant portion of the existing space inventory. 

A group containing some of the largest users/occupiers of retail space in the UK banded together and publicly challenged the existing, and previously accepted, requirement for retail tenants to pay rent quarterly in advance to property owners. This “quarterly in advance” operating model has been an accepted business practice for a long time in the property business here and is contained in most standard lease documents.

The public push back from the tenants group was surprising in that there seemed to be a call for relief regarding the “quarterly pay in advance” from existing leases in place, as well as future leases yet to be written. The owner’s response was not enthusiastic to say the least… a signed lease is a signed lease. What has worked in the past is fine. No need for change.

The newly formed tenants group stated that retail rental rates in the UK are currently some of the highest in the world. That fact, coupled with the current liquidity issues facing large companies in the retail sector, meant that the requirement to pay rents 90 days in advance had to be looked at as a relic whose time has come and gone.

The message was that tradition needs to give way to operating reality. Better to have tenants paying rents in a more affordable fashion on a monthly basis than not have tenants paying rent at all because they may not have the cash required for a 90 day in advance rental payment without impacting operations.

Interesting discussion... Changing times sometimes foster big changes. This could be a significant one as the discussion proceeds. There are some pointed undertones regarding the sustainability of the current retail market rental rate situation that are worth watching.

The opening shot has been fired in what could be the beginnings of a shift in retail real estate realities in the UK.

Getting to Know Shariah

As Middle Eastern investors look to invest in real estate and infrastructure, there is growing demand for Shariah-compliant investment – a series of ethical financial transactions that are organized in accordance with Islamic law.

The capital available for deployment into Shariah-compliant investments is vast and growing. At the heart of the Middle East, the countries of the Gulf Cooperation Council – Saudi Arabia, Kuwait, the UAE, Bahrain, Qatar, and Oman – form a market of 38 million residents (about the same population as California) with a combined annual GDP that grew 6.4 percent in 2007 to reach US$840 billion, according to RREEF. Add to this another 430 million Muslims living outside the Middle East – many of whom reside in prosperous or growing economies such as India, Malaysia, or Turkey – and the market opportunities become quite clear.

Middle Eastern investors hold US$2.4-2.8 trillion in traditional investment assets worldwide, including treasuries, corporate bonds, equities, and funds. More specifically, Shariah-compliant products (which include banking assets and asset management) were valued at around US$450 billion (ex-Iran) in 20064. With growth of 23.5 percent per year over the past five years, Shariah compliant products are expected to grow at 17 percent per year to exceed US$1 trillion in value by 2010 (ex-Iran).

The range of investment opportunities complying with Muslim religious beliefs has historically been fairly limited. Islamic banking is an ethical and equitable mode of financial services that derives its principles from the Shariah (Islamic law). The Shariah is based on the Quran and the Sunnah of the Prophet Muhammad, and it governs all aspects of personal and collective life.

Overall, Shariah investment must be carried out in accordance with the fundamental principles of Islamic law. A Shariah board of Islamic scholars advises the financial institution in the development of Shariah-compliant products. The most distinctive element of Islamic banking is the prohibition of interest, whether "nominal" or "excessive," simple or compound, fixed or floating.

Other elements include the emphasis on equitable contracts, the linking of finance to productivity, the desirability of profit sharing, and the prohibition of gambling and certain types of uncertainty. These parameters define the nature and scope of Islamic banking, as interpreted by the Shariah scholars that work with financial institutions.

Saving and investing, however, are in line with Islamic religious principles so an increasing range of financial products are now emerging to meet Shariah rules. The Islamic banking industry today is valued at several hundred billion dollars (estimates vary) and consists of more than 300 financial institutions in and outside the Muslim world.

Beyond the UAE

We've posted several blogs on the fast-growing markets of Dubai and Abu Dhabi in the United Arab Emirates. These two cities are experiencing unprecedented levels of new development, especially in the retail, hospitality and residential sectors.

Interestingly, UAE is not the only country in the Middle East to have ambitious development plans, particularly when it comes to capturing their share of the tourist market. Overall tourist numbers across the Middle East are forecast to grow at approximately 6.7 percent year-on-year between 1995 and 2020 against a world average of 4.1 percent, according to the UN World Trade Organisation's Tourism 2020 Vision.

In Qatar, for example, two mega-developments are under way: the Pearl, a 366 hectare man-made island, designed as a Riviera-style residential and leisure community that will include a significant residential offering, as well as housing three luxury five-star hotels, restaurants, leisure and entertainment facilities; and The Lusail Development, a 32 square kilometer beachfront development, scheduled for completion in 2010. As the largest real estate development in Qatar, it will provide accommodation for over 200,000 people, as well as

10 resort hotels, golf courses and retail outlets.

Oman and Bahrain also have huge projects. In Oman, the Blue City Project on the coast will provide accommodation for over 250,000 residents and will aim to attract two million tourists, while the Wave Muscat is a tourist-focused resort development built around a Greg Norman golf course and including a major nature reserve as well as four world-class hotels and a 300-berth marina.

In Bahrain, a 20 square kilometer man-made island development is under construction; it will house up to 35,000 residents across 13 man-made islands and will include two luxury five-star hotels, marinas, retail, restaurant and entertainment facilities and an 18-hole golf course.

Investing in Emerging Markets

By Melissa Securda

High borrowing costs and lenders reducing the amount available debt are two far reaching effects of the global credit crunch. Markets in Europe are suffering, the London office market is seeing signs of a slowdown, and it’s no secret the US market also feels the pain. What opportunities are there for investors today?

The International Monetary Fund has designated 50 countries as "emerging" – 18 of these are in Europe. Massive economic growth and rising demand across all real estate sectors drives increasing investments in these markets. 

Developing and emerging markets offer investors lucrative investment alternatives, and investors are not holding back. A report by Real Capital Analytics indicated that the number of transactions in emerging markets jumped 43 percent during first quarter 2008, while those in developed countries fell 54 percent. In the past 12 months, property acquisitions in emerging markets totaled $162 billion; Eastern Europe alone accounted for $25 billion in property sales during that time frame. 

The BRIC Nations – Brazil, Russia, India, and China – have attracted global attention from fund managers because of their high-growth, high-risk real estate markets. A flood of capital continues to pour into these nations experiencing rapid economic growth, booming population growth in major cities, and improving sophistication of their real estate markets.   

Objectively looking at emerging markets, investors face numerous challenges in a developing nation including corruption, poor transparency and under-developed infrastructure. Over time, and with an increasing number of global transactions, these obstacles will lessen. For now, construction activity, tenant demand, and availability of investable product attract investors despite the challenges of doing business in an emerging market. 

Hotel Buyers & Sellers at Stalemate

For the first time in five years, more hotel owners are choosing to hold onto their assets rather than sell them, according to Jones Lang LaSalle Hotels’ recently released Hotel Investor Sentiment Survey (HISS). More than 38 percent of investors intend to hold their assets, while 37 percent of respondents say they are net buyers.

"The elevated hold sentiment evidences that many owners believe the investment market will not support their pricing expectations," says Arthur Adler, managing director and CEO-Americas for Jones Lang LaSalle Hotels. "Investors would like to acquire assets for prices at which owners are not willing to sell, resulting in a classic stalemate."

The increased short term hold sentiment corresponds to the significant decline in hotel transaction volume in 2008. While cash flows remain relative strong, sellers are not trading out of assets unless compelled to do so due to debt maturity, fund-life issues, capital requirements and the like, Adler notes.

At the same time, the ratio of buyers to sellers remains consistent with previous surveys at 5:2, points out Kristina Paider, senior vice president for Jones Lang LaSalle Hotels. “The interest in buying hotels is there, the deals just aren’t getting done in this illiquid debt environment. The propensity to hold assets versus sell now matches that, also at 5:2; the build sentiment has declined,” she explains.

Dominant hold strategies were reported in a number of markets across the Americas. In the U.S., Tampa and Philadelphia are among the cities exhibiting a dominant hold sentiment, at 51.7 percent and 50 percent, respectively, followed by Denver and Atlanta. The Canadian markets surveyed also saw a jump in investors’ intention to hold.

The dominant hold sentiment is indicative that investors have not met their pricing and return hurdles. The lowest hold sentiment was recorded in high entry barrier markets such as New York, San Francisco and Washington, D.C.

"Investors are deploying renovation strategies now to improve their position for future trading and wait it out during this period of illiquid debt and perception gaps in pricing," Paider says. "Many investors are taking this opportunity to upgrade their assets and improve performance."

Best Place for Industrial Facilities: Central & Eastern Europe

Three out of Europe’s top five markets with the best location for industrial/logistics facilities are in Central and Eastern Europe, according to the European Distribution Report 2008, produced biennially by global real estate consultant Cushman & Wakefield (C&W).

"It comes as no surprise that the Central and Eastern European countries have risen up the ranking featured in the European Distribution Report," says Ferdinand Hlobil, head of Industrial for Cushman & Wakefield in Central Europe. "We are seeing these CEE markets steadily mature as distribution hubs and lines are developed to supply the growing local markets as well as business continuing to seek a cheaper cost base.”

The top position in this year’s ranking is retained by Belgium. In second place is the Netherlands, followed by Hungary, the Czech Republic and Poland in fifth place, while Slovakia is the highest new entry at No. 9.

The European Distribution Report 2008 includes 25 country locations compared with 15 in previous editions. Reflecting the expansion of the European Union and the growth patterns of international business, most new entries are along Europe’s eastern boundaries.

The overall ranking is formed by analysing a range of weighted cost/benefit factors, including factors such as rents, labour costs, congestion, the size of freight markets by type, proximity to key markets and population densities.

“Central & Eastern Europe are maturing and growing  markets, with tremendous near and mid-term potential," says Steven Watt, head of European Logistics & Industrial for Cushman & Wakefield. "However, for the moment the geographical axis of the UK, Belgium, the Netherlands, France and Germany still form the economic powerhouse  of Europe, and thus remain home to the region’s biggest industrial/logistics markets.”

India's Green Efforts

The green building and sustainable movement continues to gain momentum in the United States, but many people question the true impact our efforts can have on global warming when emerging countries such as India and China continue to operate in non-sustainable ways.

Yet both India and China also are taking steps to avoid an environmental crisis. In a recent research report titled "Sustainable Real Estate Development in India", Jones Lang LaSalle Meghraj highlights the increasing trend of sustainable development in India. There is greater consciousness towards the environmental crisis in India with terms such as sustainable development, corporate social responsibility and triple bottom reporting becoming more common in the real estate industry.

The report also details the best practices and processes that owners and occupiers can adopt to reduce the environmental impact of their real estate assets and at the same time, gain from substantial ROI (Return on Investment) from their ‘green’ initiatives. It also points out that despite the ever rising construction activity, awareness of sustainability in India has significantly lagged behind countries in the West. Nevertheless with the growing importance of environmentalism in India, the Indian commercial sector has begun to make conscious efforts towards creating sustainable real estate.

With support from the Indian government, almost 40 construction projects that are currently underway are registered with the Leadership in Energy and Environmental Design (LEED). LEED is soon emerging as the preferred rating system as it is flexible enough to be applied to a diverse variety of markets and also because it enjoys the greatest recognition of the various international rating systems. This recognition is especially important when one considers that a prime motivator for developers to create a certified sustainable building is to differentiate their project from competition.

The government has introduced several schemes to encourage sustainability such as the Indian Renewable Energy Development Agency (IREDA) schemes for subsidising capital for installation of solar water heaters, encouragement of energy audits and management schemes, mandatory use of fly ash-based construction material, groundwater and rain water harvesting and most importantly increased monitoring of air and water pollution.

Is it a Tenant's Market for Office Space?

The U.S. office market recorded modest positive net absorption during the second quarter, propelled by pockets of economic health in a select few markets and pre-leased deliveries in other markets. Net absorption remained negative for the year as tenant demand and leasing activity slowed further as companies across industry sectors wrestled with the economic environment and real estate decisions. Nationally suburban markets recorded occupancy gains during the quarter, while CBD markets experienced declines in aggregate.

Despite almost no statistical change in vacancy, which remained at 14.3 percent overall, the pendulum of leverage shifted (modestly) away from landlords toward more balanced or tenant favorable conditions. Though several specific markets face near-term oversupply potential, the aggregate supply risk in the U.S. office market remains low. Challenging financing conditions, elevated construction costs, and weakened demand prospects curtailed office construction starts in most markets, especially in the suburbs. However office development already underway will put upward pressure on vacancy and increase options for tenants.

While the pendulum may be swinging, there is still limited distress on the landlord side. Face rents have held relatively firm in most markets, and even grown slightly in some Class A segments where high-priced new construction created a statistical "averaging up" effect. The balance of power is changing, however, and tenant incentives have risen materially in many markets impacting effective rent levels.

Experts expect companies to continue to retrench from a business perspective, but most do not foresee declines in occupancy matching the dramatic fall-off in demand experienced in 2001. Vacancy will inch upwards nationally in 2008 including an increase in sublease availability, and expect downward pressure on effective rents to mount.

Interesting Dynamics in Atlanta's Urban Office Markets

By Melissa Securda

Recently, I met with Chris Shaner, director of research at Atlanta’s Cushman & Wakefield office, to discuss the Atlanta office market and what the city can expect to see going forward.  With a total inventory of over 133 million square feet, Atlanta has one of the largest office markets in the U.S.

The interesting story lies in the urban submarkets of Buckhead, Midtown, and Downtown, comprising over 43 million square feet of office space, where construction activity and vacant space weigh on the market. 

Of the three urban submarkets, Downtown is the healthiest, reporting nearly 400,000 square feet of positive absorption to date. There has been a reduction in excess sublease space created by the law firm exodus two years ago; more leasing activity took place here than in Buckhead or Midtown. Shaner explained that the downtown submarket is tightening and with the discounted rates, tenants are drawn to the location. Despite the positive activity, no rental rate growth has been seen yet.   

Direct vacancy has increased 2.6 percent in the past year in Midtown Atlanta, and with 1.2 million square feet of speculative space under construction, this number could increase over the next two years as the 271 17th Street (534,120 square feet) and 1075 Peachtree (699,000 square feet) deliver in 2009 and 2010 respectively. 

217th is 20 percent leased to law firm Womble Carlyle, but 1075 Peachtree is purely speculative. Shaner points out that the lease to Womble Carlyle did not have an impact on absorption because the law firm was already a tenant in Midtown. He indicated that many tenants are moving around the submarket, but few tenants are relocating into the area. With nothing else in the construction pipeline, the new space should not have a detrimental impact to the submarket.

This may not be the case, however, in Buckhead where over 1.9 million square feet is under construction on a purely speculative basis. Shaner explained that most of the developers of these projects are large institutional owners who want to own trophy property in Buckhead.

Because of the current lending situation, and the bid-ask spread differential, it made more economic sense to build a new building to hold, rather than buying an existing building. Unfortunately, there are not enough tenants to go around and Buckhead landlords are enticing tenants to renew early, in the hopes of keeping strong tenants from seeking newer space with hefty concessions. 

Local reports indicate a “bloodbath” among landlords when these large projects deliver throughout 2009 and early 2010. Shaner responds to this by saying:  “Whether we’re economically recovering, stabilizing or still falling will dictate the degree to which we see a 'bloodbath'. If nothing else, I think we can safely predict an increase in vacancy and landlords’ blood pressure levels.”