After admitting to wringing her hands throughout the previous night’s high-profile game between the Boston Red Sox and the New York Yankees, Susan Hudson-Wilson told a crowd of investors, developers and brokers at the annual convention of the National Association of Industrial and Office Properties that, "Nervous is good. Nervous keeps you edgy."

Hudson-Wilson, founder and CEO of Boston-based Property and Portfolio Research Inc., advised commercial real estate investors attending the conference in San Diego on Oct. 19-22 to be just as cautiously optimistic about their investment portfolios.

Investors and developers are feeling the pain of inflation in several areas. Hudson-Wilson said building replacement costs have shot up 10% in one year. In addition, construction material prices are skyrocketing — steel is up 23% in one year and rebar is up 65% — leading to rapidly increasing development costs.

However, "There’s a big, huge silver lining. As construction costs rise, new construction doesn’t pencil," Hudson-Wilson said. Of course, a limited supply of real estate benefits buildings owners as demand for space increases.

Fortunately for investors the real estate market is flush with capital. Hudson-Wilson explained that household debt makes up 50% of all debt, and when consumers hold off on big purchases, banks have more money for government and business borrowers.

Hudson-Wilson estimated that institutional capital makes up the vast majority of funds available. International investors are in a distant second place. "Who’s late to this party? Institutions — pension funds and their managers," Hudson-Wilson said. "They’re embarrassingly late."

Institutional players waited for the market to crash in order to find some good buys, according to Hudson-Wilson. They sat on the sidelines, watching private investors make acquisitions, she says. Those buyers are selling their properties back to the institutions and making a tidy profit.

With institutional investors’ increasing appetites, Hudson-Wilson predicted that they will contribute to making the office market an "outperformer" compared to any other property type. She said returns on office property totaled 5.7% in 2003, more than one percentage point higher than 2002. Property & Portfolio Research predicts that returns on office investments will continue to rise through 2008.

However, Hudson-Wilson warned that demand for space could slow as workers in the Baby Boom generation retire and members of Generation X — a much smaller group — take their place. By 2008, she said building owners could be feeling that dip. Between 1982 and 1992, employers demanded 180 million sq. ft. of office space annually. Hudson-Wilson said that demand will likely drop to one-third of that number, or 50 million to 60 million sq. ft. each year.

Despite the amount of capital pouring into the commercial real estate market, Hudson-Wilson said the industrial sector will not be dominated by institutional and international investors, because they are not apt to buy one or two warehouse buildings at a time. Institutions instead will purchase select industrial property portfolios.