All of these market dynamics make a substantial price correction unlikely. In fact, only eight percent of respondents expect a major pricing correction, while 90 percent expect there to be a minor or modest pricing correction for commercial real estate assets.

Tokarski forecasts a five percent to 10 percent decrease in pricing for top-tier real estate and a 10 percent to 15 percent decrease for assets in secondary and tertiary markets. If the market does experience a 10 percent pricing correction, that 10 percent corresponds directly to the appreciation commercial property experienced from fourth quarter 2006 through first quarter 2007 when underwriting was at its most aggressive.

“Many buyers have become more cautious – as have lenders – and there is much more focus on real income as opposed to aggressive pro forma expectations,” Green explains. He, too, expects buyer demand and pricing for higher-quality assets in primary markets will remain strong, while lower-quality assets will see more of an adjustment, especially in secondary and tertiary markets.

Respondents expect cap rates to increase for all property types over the next 12 months, but the increase is expected to be slight – only 29 basis points. As of early October, the average cap rate for commercial property was 6.94 percent, according to Real Capital Analytics. In 2006, the average cap rate was 7.12 percent.

The upward pressure on cap rates comes from the credit crunch and the looming threat of recession, Nadji says, adding that cap rates for top-tier properties are not expected to rise more than 25 basis points while cap rates for lower-tiered properties and markets will increase 50 basis points to 75 basis points.

Bob Dougherty, chief acquisitions officer with Buchanan Street Partners, has already seen a 25-basis-point increase in cap rates.  “Many cap rates have been predicated on the availability of cheap debt, and that’s driven pricing to artificially high levels,” he notes.  “We’ve been underwriting a 100-basis-point increase in cap rates for almost two years because we’ve been expecting a correction. Now we think cap rates will return to historical norms of 200 [basis points] to 300 basis points over Treasuries.”

But NorthMarq’s Butchenhart is less confident that returns will ever return to historic levels. “Real estate is recognized as a strong asset class by most investors today, so returns are not going to go back to where they were when investors didn’t recognize the asset class,” he says.

APARTMENT APPEAL

Apartments and mixed-use assets are the most attractive to respondents. In fact, 33 percent of them say they’ll enter the apartment sector in the next 12 months, and 19 percent indicate they’ll enter or expand into the mixed-use sector. Office properties and retail assets rank far lower with investors, according to the survey.

Investors are increasingly interested in the apartment sector. In 2004, for example, roughly $51 billion worth of apartment assets changed hands in the U.S. – about $1 billion less than the volume of transactions during the first three quarters of 2007, according to Real Capital Analytics.

Today, much of the investor interest in apartments is driven by the weakness in the housing sector and continued upheaval in the mortgage markets. “With both the condo market and the single-family home market falling apart, people have to live somewhere, so they’re going to rent apartments,” Yeskey points out.

Buchanan Street Partners is bullish on the apartment sector, Dougherty says, and plans to grow its portfolio by investing in the multifamily sector. “We like the demographic and demand trends in the sector because affordability of single-family housing is out of reach of many people,” he explains. This year, the company is on track to close $325 million to $350 million in new equity investments. Next year, it is shooting for $400 million to $450 million.

Dougherty, along with many other investors, expects apartments to benefit from increased pricing and rental rates. In fact, three out of four respondents who are currently invested in apartment properties predict an increase in effective rents, and nearly one-third expect to see an increase in the market pricing of apartment properties. More than half of those who invest in apartments expect a slight or major increase in cap rates.

As of October, the average cap rate for apartment properties was six percent and the average price per unit was $104,857, according to Real Capital Analytics. To compare, the average cap rate in 2004 was 8.66 percent and the average price per unit was $67,776.

Alan George, chief investment officer for Equity Residential, says cap rates for Class B and C apartment properties have increased 25 basis points and 75 basis points, respectively, since mid-summer. “I think cap rates for those types of assets has plateaued, and I wouldn’t expect more of an increase in 2008,” he notes, adding that Class A cap rates have moved very little.

Some industry experts are less enamored of apartments. Yeskey, for example, feels apartment cap rates are too low for most investors to make a good return. “I really worry about the cap rates on apartments – investors better be sophisticated operators because there’s not a lot of juice there,” he says.

Beyond apartments, Nadji says there are investment opportunities in office and retail. “The office market still has a lot of room to run, and the concerns about the retail sector are overstated,” he contends.

Nadji points out that the office leases that were signed from 2002 to 2004 were at the bottom of the market. “When tenants renew in the future, there is a mark to market that should result in higher rental rates and revenue increases,” he explains.  Three in five downtown office investors expect effective rents to increase, and nearly half of suburban office investors expect rents to increase. These numbers are consistent with the 2006 findings.

As for the retail sector, Nadji admits that that there are some valid concerns about consumer spending, which has dropped off significantly this year. But he contends that retail sales are still growing and retail fundamentals are still strong. Most projects that are under development are preleased, preventing serious overbuilding in most markets and keeping the expected rise in retail vacancies moderate.

Property types aside, Nadji expects continued investor interest in properties that they can renovate, redevelop or expand. Nearly half of respondents (45 percent) plan to acquire properties specifically for redevelopment, renovation or expansion. More than two-thirds of developer respondents (70 percent) plan to acquire properties for this purpose. SCI, for example, is raising a $50 million fund specifically to invest in value-added properties in infill locations.

“In a low-yield environment, it is not surprising to see the appetite for value-add investments, but these types of assets will be harder to finance because of the risk level,” Nadji says. “For investors with cash and a higher tolerance of risk, value-added properties will present a great opportunity.”

George agrees: “I think the value-added sector is a more difficult business today than it has been in the past, but rehabs of quality assets in quality locations always make sense.”

View full PDF of the 2008 Real Estate Investment Outlook