Jones Lang LaSalle
About Real Estate: A Free TWR Weekly Publication
January 27, 2006 Volume 7, Number 3
Filling In For Ray Craig Thomas, SVP, Director of Research & Research Systems
cthomas@tortowheatonresearch.com
Woe is me! Difficult is the life of an economist! As I sit down to write this, it's 5:00 am, I'm bleary eyed, the coffee hasn't quite found its way to my brain, and I'm left to reflect on the happiness that I abandoned when I turned off the alarm and placed my feet on the cold floor. Oh, woe is me!
You might now be wondering how such misery might have befallen me. Well, let me quickly lay out the plot: Boy is happy at work, unsuspecting of what lay ahead. Real estate luminary and captain of industry, Ray Torto, is on the schedule to contribute an About Real Estate article. Said real estate luminary goes on the road with intention of writing on the plane. Airline placates passengers with a parade of charming videos including a piece on funny pet antics and several hidden-camera sketches. Real estate luminary wonders where time went. Boy gets call that he's on the hook to write an article. Finally, we find our protagonist sad and alone at 5:00 am staring at a computer.
Now mind you, I'm not sore about it. Ray Torto is out there on the road conveying our analysis to clients and colleagues and will surely bring important insights back to the rest of us that will only improve our understanding of the marketplace. Such trips are certainly time well spent, so if I have to get up a little early to make it all possible, then I'm happy to do it. My only problem is how can this wet-behind-the-ears cub-economist step in for such a man?!
Fortunately, having seen him around the office, I do know him a bit and I have a sense of where his mind is. I think if I just follow the company mantra of W.W.R.D.--What would Ray do?-- I'll be able to get through this in good shape.
So--what would Ray do?
Well, Ray tends to care about only one thing at work, and that is helping the real estate investor to understand the marketplace, and the opportunities and risks within. The methodology for understanding the marketplace it to begin with the best data and evaluate it through the lens of properly applied economic theory. We do this in the hope that our clients will take advantage of asymmetrical information and, better informed than those investors who are not our clients, be better able to plan their course of action and stay one step ahead of the huddled masses.
But what of the here and now? W.W.R.D? Well, I've noticed that Ray has been increasingly compartmentalizing real estate into two components these days. This has happened almost organically as we have observed markets. There are the market fundamentals: completions, absorption, rents and vacancies. Then there are the capital markets, which are the forces that decide cap rates and equity flows to real estate. The capital markets have been so active over the last few years that they've acted almost independently of the fundamentals market, which--in my view anyway--is unique.
It's analogous to a company's stock price moving without reference to the prospects of that company's revenues and profits. Certainly it happens, but I still think it's odd to think of tons of brick, steel and dry wall pirouetting in a manner reminiscent of, say, something as insubstantial as common shares of Snapple (back when Snapple had common shares). That's not to say that the market is not justified or rational, but the point is that the capital market has been more active than have the market fundamentals. And that in and of itself is interesting.
It is all the more interesting right now because it appears that the two components, capital markets and market fundamentals, are at the cusp of changing roles. If we here have been surprised at anything of late, it has been the above-expectation performance of the fundamentals. We expected improvement, but at a slower pace.
Across every property type TWR looks at, including retail, office, industrial, multi-housing and hotel, absorption is up, availability is falling, and rents are firm and rising. Moreover, the economic expansion appears to have legs. Weekly jobless claims have been below 300,000 in three of the last four weeks. Unemployment is at 4.9%. Capacity utilization is at 80.7%, inventories are almost dangerously lean and orders for new goods continue to rise. It really does appear that the fundamentals market is where it's at these days.
As to the capital market, well, it's still quite good. Don't get me wrong. Pricing continues to be aggressive. However, from the vantage of the real estate speculator, I believe that capital markets have ceased to improve. Now this is a point of disagreement, I confess. The fourth-quarter NCREIF numbers do suggest that cap rates fell throughout the year, fourth quarter included. At the same time though, looking at actual transaction data from Real Capital Analytics and after communicating with professionals in the field, there is a growing consensus that the cap rate compression is over, which really does make intuitive sense. Interest rates have stopped falling and competing investment classes have shown some life.
So, we're at a crossroads of sorts. Market fundamentals are coming to life, and the capital market is losing a bit of its shine. This will be hugely important to investors, because asset appreciation will now flow exclusively from increases in rental income, and not from falling cap rates. This is a real about-face, and I would have to conclude that this point is what Ray would want me to convey to you the reader.
This also brings up two very interesting questions. First, because the assets that generate the most income growth will now be the best performers in terms of asset appreciation, one has to ask which markets are poised to provide such growth. Second, after all the aggressive pricing are the markets that are priced most aggressively the same markets that are set to see strong growth? I think you know what I'm getting at.
Are there markets that are poised to not only generate strong rental income growth, but also priced less aggressively? The answer is yes! Take a look at the chart below. The green dots toward the upper right would be markets with high cap rates and strong income growth prospects. The ones to the lower left would be the markets you may want to avoid--low cap rates and low future rent growth.
About Real Estate: A Free TWR Weekly Publication
January 27, 2006 Volume 7, Number 3
Filling In For Ray Craig Thomas, SVP, Director of Research & Research Systems
cthomas@tortowheatonresearch.com
Woe is me! Difficult is the life of an economist! As I sit down to write this, it's 5:00 am, I'm bleary eyed, the coffee hasn't quite found its way to my brain, and I'm left to reflect on the happiness that I abandoned when I turned off the alarm and placed my feet on the cold floor. Oh, woe is me!
You might now be wondering how such misery might have befallen me. Well, let me quickly lay out the plot: Boy is happy at work, unsuspecting of what lay ahead. Real estate luminary and captain of industry, Ray Torto, is on the schedule to contribute an About Real Estate article. Said real estate luminary goes on the road with intention of writing on the plane. Airline placates passengers with a parade of charming videos including a piece on funny pet antics and several hidden-camera sketches. Real estate luminary wonders where time went. Boy gets call that he's on the hook to write an article. Finally, we find our protagonist sad and alone at 5:00 am staring at a computer.
Now mind you, I'm not sore about it. Ray Torto is out there on the road conveying our analysis to clients and colleagues and will surely bring important insights back to the rest of us that will only improve our understanding of the marketplace. Such trips are certainly time well spent, so if I have to get up a little early to make it all possible, then I'm happy to do it. My only problem is how can this wet-behind-the-ears cub-economist step in for such a man?!
Fortunately, having seen him around the office, I do know him a bit and I have a sense of where his mind is. I think if I just follow the company mantra of W.W.R.D.--What would Ray do?-- I'll be able to get through this in good shape.
So--what would Ray do?
Well, Ray tends to care about only one thing at work, and that is helping the real estate investor to understand the marketplace, and the opportunities and risks within. The methodology for understanding the marketplace it to begin with the best data and evaluate it through the lens of properly applied economic theory. We do this in the hope that our clients will take advantage of asymmetrical information and, better informed than those investors who are not our clients, be better able to plan their course of action and stay one step ahead of the huddled masses.
But what of the here and now? W.W.R.D? Well, I've noticed that Ray has been increasingly compartmentalizing real estate into two components these days. This has happened almost organically as we have observed markets. There are the market fundamentals: completions, absorption, rents and vacancies. Then there are the capital markets, which are the forces that decide cap rates and equity flows to real estate. The capital markets have been so active over the last few years that they've acted almost independently of the fundamentals market, which--in my view anyway--is unique.
It's analogous to a company's stock price moving without reference to the prospects of that company's revenues and profits. Certainly it happens, but I still think it's odd to think of tons of brick, steel and dry wall pirouetting in a manner reminiscent of, say, something as insubstantial as common shares of Snapple (back when Snapple had common shares). That's not to say that the market is not justified or rational, but the point is that the capital market has been more active than have the market fundamentals. And that in and of itself is interesting.
It is all the more interesting right now because it appears that the two components, capital markets and market fundamentals, are at the cusp of changing roles. If we here have been surprised at anything of late, it has been the above-expectation performance of the fundamentals. We expected improvement, but at a slower pace.
Across every property type TWR looks at, including retail, office, industrial, multi-housing and hotel, absorption is up, availability is falling, and rents are firm and rising. Moreover, the economic expansion appears to have legs. Weekly jobless claims have been below 300,000 in three of the last four weeks. Unemployment is at 4.9%. Capacity utilization is at 80.7%, inventories are almost dangerously lean and orders for new goods continue to rise. It really does appear that the fundamentals market is where it's at these days.
As to the capital market, well, it's still quite good. Don't get me wrong. Pricing continues to be aggressive. However, from the vantage of the real estate speculator, I believe that capital markets have ceased to improve. Now this is a point of disagreement, I confess. The fourth-quarter NCREIF numbers do suggest that cap rates fell throughout the year, fourth quarter included. At the same time though, looking at actual transaction data from Real Capital Analytics and after communicating with professionals in the field, there is a growing consensus that the cap rate compression is over, which really does make intuitive sense. Interest rates have stopped falling and competing investment classes have shown some life.
So, we're at a crossroads of sorts. Market fundamentals are coming to life, and the capital market is losing a bit of its shine. This will be hugely important to investors, because asset appreciation will now flow exclusively from increases in rental income, and not from falling cap rates. This is a real about-face, and I would have to conclude that this point is what Ray would want me to convey to you the reader.
This also brings up two very interesting questions. First, because the assets that generate the most income growth will now be the best performers in terms of asset appreciation, one has to ask which markets are poised to provide such growth. Second, after all the aggressive pricing are the markets that are priced most aggressively the same markets that are set to see strong growth? I think you know what I'm getting at.
Are there markets that are poised to not only generate strong rental income growth, but also priced less aggressively? The answer is yes! Take a look at the chart below. The green dots toward the upper right would be markets with high cap rates and strong income growth prospects. The ones to the lower left would be the markets you may want to avoid--low cap rates and low future rent growth.
posted by Jones Lang LaSalle NJ News Blog at 10:49 AM
<< Home