With skyrocketing oil prices, anemic job growth and the likelihood of rising interest rates, commercial real estate investors should brace for a choppy investment environment in 2005, according to a panel of four real estate industry veterans who spoke during the Pension Real Estate Association’s 25th annual Plan Sponsor Real Estate Conference held Oct. 20-22 at the Beverly Hilton in Los Angeles.
"This has been the worst jobs recovery on record," said Ken Rosen, chairman of Rosen Real Estate Securities during the discussion, entitled "Real Estate in a Single-Digit Return Environment."
Rosen was joined on the panel by Smith Barney REIT analyst Jonathan Litt, Michael Giliberto of JP Morgan Fleming Asset Management and moderator Wylie Greig, global director of DB Real Estate.
If oil prices remain north of $50 per barrel for another six months, Rosen believes that the U.S. economic recovery could be further hampered. He also believes a decisive, large-scale attack on Saudi Arabia’s oil refineries could push oil prices even higher. "This is a very risky area for the United States," he said.
So what returns should real estate investors expect over the next five years? According to JP Morgan Fleming’s Giliberto, unleveraged returns should yield 7% over that period, but that number could be "too conservative," he added.
The panelists agreed that rising interest rates should push cap rates up across property classes. In fact, Rosen projects that core cap rates could rise about 150 basis points over the next few years.
REIT analyst Litt noted that there are so many economic data points to consider when formulating any real estate forecast, it’s difficult to reach any conclusion. "The bad scenario for real estate is higher interest rates and less job growth obviously," said Litt. "My outlook is that for the next two or three years the real estate market will be a tough place."
Litt also said that the REIT market could see a substantial "20% correction" next year. Many REITs are trading at a 25% premium to the value of their underlying real estate. "Real estate overall is quite pricey right now," Litt said.
Overbuilding in the office sector may even be a problem within the next 18 to 24 months, said Litt. The reason? "There’s so much capital chasing real estate now and it’s hard to find deals. If it’s too expensive, they will build it."
According to Giliberto, the office market isn’t overbuilt — yet. Fundamentals are improving — albeit slowly — due to long-term leases gradually rolling over. "This is not a spectacular recovery story," said Giliberto.