Economic Conditions

Alert to reviving markets, real estate investors, builders and lenders are accelerating growth plans. Strategy is rotating to the fore in a period of comparatively long business cycles. Interest rates should decline in 1996 with short term rates falling about 50 basis points. Real corporate profits are at unprecedentedly high levels but corporate office needs are mixed. Mergers will affect demand in 1996.Even though real disposable personal income rose 3.3%, soft goods sales are lagging. Industrial and retail development is on the rise. Sound underwriting standards must remain in place as the property markets return to balance.

The Office Market

Improved current returns and growing confidence in the future is propelling office markets forward. Offices will continue as the "hot" property type. Pension funds, appetite for additional properties has been whetted. Office REITs returned an excellent 18.7%. Life insurers have commercial capital available. Entrepreneurs and niche players can find ample product across the country at a substantial discount to replacement cost. The 1991-1995 decline in vacancies should decelerate in 1996. Supply/demand conditions for 60% of U.S. markets should be favorable over the next five years. Momentum Index rankings reflect general improvement and wide variation in individual markets. Orlando tops the Index again. Charlotte and Atlanta achieve MQR 2 ratings as do Salt Lake City and Sacramento. Denver and Phoenix reached significant milestones by stepping up to MQR3 ratings. The markets are still fragile, and even a modest rise in construction will slow the pace of improvement.

The Retail Market

The consolidation of department stores prompted national chains to re-examine their approach to retailing with generally good results. But, the women's apparel sector and shoe stores have struggled. Consumers are spending on computers, appliances, sporting goods, jewelry and furniture. Discounters and power centers are formidable players, and "outlet megamalls" are the monsters of value retailing. Remerchandising and service are the bywords for malls in fighting back. Investor interest is sharply reduced, but good quality malls, with high returns are sought by RElTs and others. Most owners, though, are not eager to sell. Discounters are penetrating the Northeast, with big box retailing coming to the New York boroughs and power centers flexing their muscles in Philadelphia. Excessive development risks are evident in the Sunbelt's "hot" markets like Dallas and Atlanta. Denver and Phoenix are volatile. Chicago should be a solid regional performer.The West Coast is seeing fierce competition between regionals, big boxes and power centers. Retail is trending toward the bottom of investor preference. No cause for panic; just part of the natural cycle.

The Industrial Market

Returns began flowing at double-digit rates in 1995. Construction is rising and there is enough spec development for some concern. Financing is affordable; underwriting terms are easier; loan-to-value ratios are more generous; debt service coverage is down and cap rates have fallen. Average vacancy rate in the 60 markets we review is down to 7%. Spot shortages may necessitate spec development in some markets, but the manufacturing sector should cool off during the next two years. The South Atlantic states and Texas are well represented on our Power Rating lists. Atlanta has been the most active industrial market in 1995. Minneapolis holds top ten positions in both R&D and distribution. Seattle and Portland industrial occupancies are in the mid-to-high 90%.

The Residential Market

This property type is peaking. Apartment complex construction is up and high building volume in many markets could limit returns between 1996 and 2000. Double-digit returns for 1994 and 1995 continue to lure investors. Financing should pose no problem this year. Realizing capital gains through sale or refinancing is a good strategy since pressure on values will mount as vacancies increase. On the ACIS scale, the top markets are again in the West. Oakland tops the list followed by Honolulu and San Diego. Las Vegas slips to 10th place. Dallas and Fort Worth are promising; Houston still has a steep climb back. Apartment conditions are solid in Chicago and Minneapolis. The Atlantic Seaboard, except Philadelphia, is improving. Investors who moved into multi-family five years ago should be pleased with their foresight and should consider reaping gains.

The Hotel Market

More guests, spending more for their rooms, pushed occupancy levels in our 42 hospitality markets up to 70.1%.Construction is increasing, but is well within the demand indicators for 1996. Business and vacation travel is booming, and a favorable foreign exchange rate is boosting tourism. Hotel operators are aligning with investment firms to access capital markets.Hotels should be even more active in issuing securitized debt. Operators and management companies should brace for more consolidations.High utilization rates which cannot be sustained and the potential for technology to negatively affect business travel are two danger areas. Property tax increases are a likely side effect of increased values. Our Equilibrium Index is strengthening. Las Vegas has regained the top spot, trailed by New York and Atlanta. The easy money was made in the past two years. But hospitality should be a good sector for investors in 1996.

What to Watch For

Advantages of greater size are moving to the fore. "Re-flagging" will concentrate power with major hotel operators. Office investors will favor suburban markets and smaller cities. For offices in 1996, small is beautiful. By 2000, bigger will be better. Retail investors will stay on the sidelines. Size will count here later in the decade. Capital will be readily available from many sources. We expect a higher level of attention to real estate fundamentals as holdings of equity and debt securities grow.The laws of supply and demand will assert themselves no matter how fast moving and complex the industry changes, or how exotic the investment vehicles.