The measures that investors utilize when acquiring real estate provide an effective indication of investor attitudes and future trends of values for each market area covered in our survey. VIL offices constantly monitor these criteria when analyzing comparable sales data. The following discussion is a review of the market performance of the investor criteria by property type, and a look at expectations for change through the next year.

Cash Flow Forecast Assumptions, Year-End 1995

Data collected as of year-end 1995 includes going-in capitalization rates, discount rates, reversion capitalization rates, market rent change rates, expense change rates and tenant finish allowances. Theses rates are presented in Table 23 for the reader's review.

Capitalization rates are a measure of performance and an indication of value; they reflect expectations for income growth, duration and perceived risks. In general, lower initial capitalization rates indicate a greater expectation of future durability and growth in net income and lower overall risk.

The discount rate is the annualized rate or unleveraged rate of return an investor expects a property to yield. Commonly known as the "internal rate of return" (IRR), the discount rate, when used in evaluating a property, isolates the perceived risk. This rate is applied to convert anticipated monetary benefits to an indication of present value. Typically, lower discount rates reflect lower perceived risk.

Retail

In the retail sector, regional malls are the only property type to experience an increase in capitalization rates, when compared to last year. This year's 8.3% going-in capitalization rate is a 30 basis point increase over last year's rate. Although Class "A" regional malls are highly sought after by institutional investors, due to a lack of available quality stock and some investor concern, regional malls have lost some of their glamour. Neighborhood strip centers and community malls reported stable and declining capitalization rates, when compared to last year, currently at 10.1% and 9.5%, respectively. Stability in capitalization rates in 1995 was unprecedented by any other property type. Of the respondents surveyed, 76.3% to 85%, report expectations that capitalization rates will remain stable.

Discount rates were stable to declining in the retail sector when compared to last year. This reinforces the earlier predictions for little change in this asset type. Regional malls reported rates of 11%; community malls, 11.7%; and neighborhood shopping centers, 12.3%. Yields are projected to remain stable, as 80% of the respondents think regional mall yields will be unchanged, and 69.7% to 72.7% of those surveyed believe no changes will occur to next year's yields for community malls and neighborhood centers. Rents increased by 3.2% for regional malls, 3% for community malls and 2.8% for neighborhood centers. These are not particularly strong rental increases, especially when you consider expenses are increasing at 3.6% and 3.5%. Until rents can keep pace or exceed increases in expenses, long term investor opportunity will be hit and miss. Again, whether the investment community has yet reflected on the fundamental changes in the retail asset class provides additional concern. Only a finite number of dollars will be spent on GAFO sales and VIL's case studies suggest when "big box" supply is added to an already saturated market retail sales are spread among more square footage. Accordingly, as occupancy costs increase, additional downward pressure will be put on rents and ultimately values.

Office

Capitalization rates declined for both CBD and suburban properties, compared to last year. Down from 9.9% and 10%, the office market anticipates renewed investor activity with lower risk. The range in capitalization rates between 8% and 12% have not changed; however, more cities are experiencing a renewed interest by investors, after several years of neglect. Very few of those respondents surveyed see any future potential for increases, while the majority report stability or a further decline in capitalization rates.

Yields have declined 20 basis points for suburban properties from last year's 12.1%; however, yields for CBD properties increased by 10 basis points to 12%. Investors are cautious in CBD markets, and rightfully so. Expectations are that stability and declining yields will be enjoyed by both office markets. In fact, only 2.9% of those surveyed foresee increasing yields in suburban markets. As investor activity heats up, multiple buyers will be vying for the same properties, putting downward pressures on yields. Like retail, the office sector suffers from expenses which have outpaced rental increases. A nearly 70 to 90 basis point spread was reported, which does not bode well for long term investors if their rental spike projections are incorrect.

Apartments

The multifamily asset type stood out in last year's survey as the unprecedented favorite by investors. Investor interest has cooled somewhat, as most of the best opportunities have been "swooped up." This is evident as the suburban multi-family market was the only property type to report no change from last year's capitalization rate. Just over half of those surveyed report expectations that these rates will be stable into next year. However, nearly 35% are still forecasting declining rates, suggesting that there are opportunities still available in certain cities. Both the CBD and suburban markets boast the greatest increases in rents at 3.5% and 3.4%, respectively. This is not surprising, as most cities feel their apartment markets have peaked, and construction is either underway or just around the corner.

Suburban multifamily discount rates averaged 11.6% in 1995, unchanged from 1994. The CBD market declined from 12.2% to 11.9%, suggesting that the CBD market is also a viable market for investors. Of those surveyed, 70% anticipate yields to be stable next year for CBD properties, while only 56.3% expect suburban properties to be stable.

Industrial

All industrial property types have reported a decline in capitalization rates from last year's. The decline was nearly 30 or 40 basis points. Bulk and office/warehouse lead the group with rates of 9.9%, while research and development and manufacturing reported 10.1% and 10.2% capitalization rates. Most cities report expectations of stabilized capitalization rates; however, nearly 21% to 34% still see opportunities for rates to decline further.

All four industrial property types also recorded declines in yield rates when compared with last year. Expectations for next year are primarily for stabilization. Of the respondents surveyed, 23.5% and 28.6% forecast declines in rates for next year for bulk and office/warehouse, while only 8.8% and 5.7% expect increases.

Lodging

The third strong year of recovery in the lodging industry has attracted renewed interest among investors and lenders. All three lodging categories report declines in capitalization rates, when compared with last year. Each category declined 10 basis points, reflecting greater competition among buyers, as well as greater availability of capital. It is likely that a continued decline in capitalization rates will occur in 1996. Among the respondents surveyed, 26.9% to 37.0% anticipate a further decline in capitalization rates. Similarly, yields are expected to follow this trend, as there is greater competition among purchasers. In many ways, 1996 will be a transitional year in the lodging industry, marking an aggressive return of investors and lenders after three years of solid recovery. The return of capital will also fund new construction, and 1996 promises to be the first year of significant new construction across the United States since the late 1980s. The volume and diversity of hotel products to be constructed will be clearer at the end of 1996, but will influence future supply/demand characteristics.

Conclusion

It appears that all real estate asset types are enjoying a resurgence of investor interest and positive anticipation for the future. The apartment and industrial fundamentals are still attractive to investors. However, limited opportunities for "home run" acquisitions will be found. Office properties will most likely see an overabundance of transaction activity as buyers compete for well located properties in strong growth regions of the country. Suburban properties will sell at a fiery pace, while CBD properties will be focused completely on Class "A" properties. The retail market will offer opportunities; however, the risk is greater. No one seems to be safe as retailers battle for turf. The fallout may very likely be some major retailers who have not positioned themselves to adjust to changes in purchasers' buying habits. Powercenters and Class "A" malls will still be in demand, and well located anchored neighborhood centers should prosper in markets where overbuilding has not occurred. After three strong years of recovery, the lodging market has recaptured the interest of investors and lenders, and 1996 will reflect an active year among purchasers and developers.

The property trends suggest a total recovery, yet the only fundamental change appears to be improved occupancy nationwide. While rents are spiking in some areas, other parts of the country report flat to declining rents. Perhaps the decline in interest rates and addition of debt and equity capital provides as much fuel to the recovery as the demand changes in the respective markets. Investors should thoroughly examine the fundamentals of demand (i.e. job growth, etc.) prior to selecting a locale and property type in which to invest.