LOS ANGELES -- Despite weak commercial property values and cash flows, real estate will continue to attract capital in 2004 -- particularly from investors looking for a higher-yielding alternative to fixed-income investments including long-term Treasuries, corporate bonds and other forms of debt. “Compared with other fixed-income investments, real estate will be the asset of choice,” said Stan Ross, Chairman of the Board of the USC Lusk Center for Real Estate (www.usc.edu/lusk).
“At 6% to 8% currently, real estate yields are the lowest in a decade, but they offer a premium over other fixed-income investments,” Ross noted. He added that “many real estate investors will accept low yields at present because they think yields will improve as the economy continues to recover and property markets begin to revive.”
Because real estate will continue to attract investment in 2004, developers and property owners will have ready access to capital next year. But they need to lock in financing before interest rates start to increase. “In 2004, interest rates will be the wild card for real estate,” Ross noted. Although the Fed hasn’t give any indication that it plans rate increases, “rates will go up – the questions are when, how much and how fast,” Ross said. Companies with substantial floating-rate debt will be squeezed as their borrowing costs increase faster than their property income.
To hedge against higher rates, Ross suggested companies consider such strategies as converting floating to fixed-rate debt, switching from short- to long-term debt, increasing unsecured and revolving credit lines, issuing stock or convertible debt or using financing techniques such as interest rate swaps or caps on floating-rate loans. By restructuring their debt, locking in long-term debt at low rates, and raising new equity and debt, real estate companies will be in a strong position to acquire properties or start development projects in selected markets, particularly toward the end of next year.
In 2004, high net worth individuals, pension funds, opportunity funds, syndicators, foreign investors, REITs and other investors will continue to allocate substantial capital to property investments. “There will be strong interest in retail, research and development, and multifamily investments as well in niche markets such as urban infill,” Ross said. Until job growth picks up, investors will be cautious about investing in office properties, but attractive investments will still be found in this sector as companies dispose of underutilized or surplus properties or choose to sell properties rather than consolidate them on their balance sheets under new accounting rules. Other rules concerning business combinations, treatment of goodwill, and accounting for financial instruments could translate into investment opportunities. So could pressures on companies to restructure or wind down tax shelters.
Ross advised investors to closely track demographic and population trends to anticipate future investment and development opportunities, for example, in developing homes, apartments, retail centers and offices for the nation’s growing Hispanic and immigrant populations. He said opportunities also will be found in the public sector as cash-strapped federal, state and local governments try to form more joint ventures and alliances with developers and investors to develop or redevelop public facilities or sell assets. Governments will also seek to enter into more leases, sales or sale-leasebacks with the private sector in order to raise capital, address budget shortfalls, and dispose of underutilized or surplus properties. “Privatization of military bases, airports and other public facilities will continue to be on public agendas at all levels of government,” Ross commented. Other opportunities will be found in such markets as developing housing and other facilities for public and private universities or construction or upgrade of healthcare facilities.
“Long-term, real estate will continue to be a strong investment alternative for institutions, high net worth individuals and other investors,” Ross said. “It offers relatively high yields, good appreciation, ready availability of capital, some tax shelter for high net worth individuals, and sound exit strategies.”