Many U.S. REITs are seeing improved earnings and margins of late. However, a closer look reveals that this improvement has been largely driven by a sharp increase in recurring capital expenditures, or Capex. Fitch Ratings views this development as a sign of still-challenged property-level fundamentals. As such, the recovery in fundamentals is not as robust once recurring Capex is subtracted.

The sectors likely to see the most elevated Capex spending in the coming quarters are suburban office buildings, retail strip centers and industrial properties. This is due to the challenging leasing environment resulting from the weak economic recovery. Capex spending will support occupancy and rental rate improvements and subsequently drive same store net operating income. Elevated spending, however, will negatively impact fixed-charge coverage, though not enough to have a negative impact on existing ratings.

There is a clear bifurcation in margins among apartment REITs. Coastal-focused companies maintain margins nearly 10 percent higher than their more geographically diversified peers. This demonstrates that coastal apartment REITs spend less on Capex as a percentage of revenues than the sunbelt REITs.

It is harder to draw clear conclusions in the office sector due to a dearth of pure-play office companies and even fewer companies focused solely on central business districts and suburbs. However, the clear sectorwide increase in recurring Capex has bolstered same-store net operating income.

Regional mall margins have been more stable than those of shopping centers over the past cycle. Additionally, the noticeable decline in Capex for the shopping center sector in 2009 was partially driven by a lack of liquidity. This was because companies were more focused on addressing near-term debt maturities and husbanding capital than allocating scarce capital to Capex.

As opposed to deriving margins only from the income statement, Fitch views margins net of recurring Capex as more meaningful since recurring Capex costs are ongoing in nature. Additionally, Fitch includes recurring Capex when calculating fixed-charge coverage for REITs to ensure that all recurring property-level costs are captured.

Despite the current headwinds, margins net of recurring Capex should stabilize and improve modestly once commercial real estate fundamentals improve and REITs can begin increasing rents.

In today’s global commercial real estate market, keeping an open mind when working with your client is very important. Buyers and sellers have different motivations and reasons for pricing a piece of property. The traditional approach to valuing a property looks at comparable past sales, comparable currently sales, income capitalization and, of course, cost: What it would cost to replace the property?

With many foreign investors looking at owning valuable United States real estate, it is very likely that you will experience another way that a property could be valued by a potential buyer or seller – and, in one case, I had a client utilize the services of a feng-shui master.

In this particular instance, my clients wanted to purchase the property that they were currently occupying. As usual, I provided the buyer with numerous comparable sales and the current availability in the area, as well as what the value of the property should be based upon the capitalization approach with the property’s NOI. The triple-net rent they were currently paying was already below market, so the value that was discussed was extremely reasonable as it would already be below market after analyzing the mortgage and other expenses.

The twist came in when the client had their feng-shui master analyze the property. (Keep in mind the client was already in the property running a successful business at the location.)

The master explained that the shape of the property’s lot was not ideal, and the proposed purchase price that was being negotiated was not an optimal use of numbers. We began the negotiations at $1,200,000, and the seller countered at $1,500,000 and we had some back and forth. The final number that the feng-shui master suggested was $1,308,166.

Another twist was that the address was not ideal. It may benefit the property owner to do some research with their specific city and determine if the address could be adjusted to numbers that were considered more fitting.

When parties are dealing with international clients, cultural and nontraditional approaches need to be appreciated, and taken into consideration. With this mindset everyone wins.

The economy and the financial markets have lost some momentum over the past few weeks – softening retail sales, employment growth and industrial production combined with the once-unthinkable possibility that Greece will depart from the euro, all on top of the protracted (to put it kindly) housing slump. Stocks have sagged, and the 10-year Treasury note has fallen back below 1.8 percent, signaling that investors once again are shying away from risk.

Nevertheless, commercial real estate continues to recover at a steady pace, and there are a few bright spots that can lead us through the gloom.

Perhaps the saving grace for the industry has been the near absence of new construction. Net absorption, though not terribly strong with the exception of apartments, has been enough to move the vacancy needle lower across all property types for several quarters. U.S. office and industrial absorption in the first quarter totaled 10 and 28 million square feet, respectively. This compares with the quarterly average during 2007 (the last year of economic expansion before the Great Recession) of 15 million for office and 40 million for industrial.

The average asking rental rate for office space has been flat over the past four quarters – up 1.5 percent for Class A space and down 0.8 percent for Class B. A few technology-powered submarkets have seen double-digit rent spikes. Industrial rents have sagged a bit but are expected to firm up as warehouse demand in particular outpaces supply. This situation is entirely normal in the early stages of a leasing market recovery; rental rates are the last indicator to turn the corner.

The dollar volume of property sales in 2012’s first quarter was 40 percent above the first quarter of 2011 according to Real Capital Analytics, on top of a 60 percent surge in sales last year compared with 2010.

While loan delinquency rates remain in nosebleed territory for CMBS (above 9 percent), CRE loans at banks have seen delinquency rates decline for six consecutive quarters, down to 6.12 percent in last year’s fourth quarter. In the first quarter of 1991 – the epicenter of the last big real estate bust and the earliest data published by the Federal Reserve – the delinquency rate for CRE bank loans stood at 12.06 percent.

Banks have been loosening standards for commercial real estate loans, and demand has been rising since the fourth quarter of 2010 according to the Fed’s Senior Loan Officer Opinion Survey of Bank Lending Practices.

So let’s give a cheer for commercial real estate as we wade through what will turn out to be, hopefully, a temporary soft patch.

The California Franchise Tax Board has decided that parcel numbers will not be required to be reported on individual tax returns after it had previously announced the would be — in an attempt to ensure that only the deductible portion of real estate tax was being reported.

There has been much confusion in determining what portion of your property tax bill is and is not deductible. The FTB conforms to federal law with respect to the deduction for real property taxes. The IRS instructions for 1040, Schedule A, advise to deduct taxes paid on real estate “but only if the taxes are based on the assessed value of the property.” Accordingly, the FTB began a campaign to educate taxpayers and preparers that they could only deduct taxes that are assessed as a percentage of a property’s value, known as ad valorem taxes.

After an uproar from the preparer community, the FTB wrote a letter to the IRS requesting clarification on the matter.  The Office of the Chief Counsel responded and clarified that real property taxes may be deductible even though they are not imposed on an ad valorem, or assessed value, basis.

According to that letter, taxes that are not ad valorem could be deductible, but “must be levied for the general public welfare at a like rate against all properties in the taxing authority’s jurisdiction.” In other words, the assessment must not be for improvements that benefit only specific properties, items like adding street lights and new sidewalks would not be deductible.

The letter also states that the Office of the Chief Counsel will recommend that the IRS revise instructions and publications on the subject, to agree with the new guidance. This is good for many California taxpayers who may have a significant portion of their property taxes that are not imposed on an ad valorem basis – Mello-Roos properties are one example.

The good news for California residents is that the FTB for now will not be requiring more detailed reporting on property taxes. The FTB has decided to wait for the revisions to the IRS forms and publications, and then will provide revised California forms and instructions that are consistent with the revisions made by the IRS.

Lori Shrout is a manager at Gumbiner Savett Inc., one of the largest CPA and business advisory firms in Southern California.

According to Trepp, while the severities of CMBS investors’ losses fell in both February and March – two very good months for the sector – the losses reverted to the mean in April, with liquidations sitting about 9 percent higher than the 12-month moving average. April’s liquidation volume hit $1.4 billion, rising above the year-long average of $1.31 billion per month. By contrast, February’s volume was only 68 percent of the moving average and, in March, it was 77 percent of the average.

The number of CMBS conduit loans liquidated in April was 148, a 56 percent uptick from the 95 in March. In the same time period, liquidations came from 148 loans, equal to the 12 month moving average monthly volume.

But there is good news on the horizon as well.

According to a new report by Fitch Ratings, the firm predicts that recent increases in commercial REO assets are enough to bring down the CMBS delinquency rate. “We expect the rate to vary by about 25 (basis points) in both directions in 2012 and that the current REO inventory will put downward pressure on the delinquency rate as it is liquidated,” the firm noted. “In April, REO assets exceeded $11 billion in scheduled loan balance for the first time.”

But the trend doesn’t apply to all areas of the country equally.

A closer look reveals stark differences in REO trends by state, the report noted. For instance, in states where nonjudicial (power of sale) foreclosure is allowed, the inventory of REO assets has increased by 64 percent since the beginning of 2011. The inventory in judicial-only states (where the foreclosure process can be notably slower) jumped by 111 percent during the same term. For the current inventory of REO assets, it took on average 179 days to foreclose on properties in power-of-sale states. It took almost twice as long (323 days) in judicial-only states. Our view is that the current REO inventory from judicial-only states represents older stock that is finally making its way through the system.

After last summer’s shocks to the CMBS market, the rest of 2012 could be a very interesting ride.

Source: SNL Financial

Bay West Development’s plans to erect a luxury apartment community at 199 River Oaks Parkway in San Jose, Calif., have taken a big step forward. With the assistance of Jones Lang LaSalle’s capital-markets team, the developer has obtained $93 million in financing for the 292-unit project.

JLL, working alongside capital advisory firm Regency Capital Partners, landed a commitment from affiliates of Berkshire Property Advisors L.L.C. to provide equity for the upscale project, and procured the construction financing from a syndication of Comerica and California Bank & Trust.

With funds in hand, construction of what Bay West describes as a “tech-forward” apartment development will kick off immediately. And it comes not a moment too soon. The four-acre property sits in a high-demand location in San Jose’s Golden Triangle, less than one mile from such major Silicon Valley employers as Cisco, Altera Corp. and Micron. According to a report released by the city of San Jose last month, the current apartment vacancy rate is just 3.8 percent, a figure well below the city’s natural rate of 5 percent.

With the increase in occupancy levels comes an increase in prices and given that there appears to be no end in sight to the increasingly loud call for luxury rental accommodations, the project will likely be worth every penny of the nearly $100 million investment. Year-over-year rental rates rose 11 percent in 2011 and additional increases are expected in 2012, as per the city’s report. The River Oaks project is on track to reach completion in September 2013.

It’s happening across the country. Strong investor interest in the apartment sector continues to grow even stronger. The reasons are simple. “The national apartment market is drawing investors because of increasing demand and currently lagging new supply, producing trending toward higher rent growth,” Javier Rivera, a vice president with JLL, noted in a recent case study.

Jones Lang LaSalle Inc. will continue to provide global commercial facilities services to the Proctor & Gamble Co. for another five years, building upon its eight-year relationship with the international consumer-goods giant.

The new agreement, reached after a competitive selection process, includes integrated facility management, project development, construction management and strategic occupancy planning services for P&G’s owned and leased corporate-facilities portfolio. The corporation’s real estate portfolio includes several million square feet of offices and technical facilities in more than 60 countries in North America, South America, Europe, Africa, Asia and Australia.

“Our relationship works so well because both companies share a clear vision of enabling business performance through real estate,” said Tod Lickerman, CEO of corporate solutions at JLL. “Both Procter & Gamble and Jones Lang LaSalle are committed to leveraging strategic real estate investments as a competitive advantage.”

Lydia Jacobs-Horton, director of global facilities & real estate for Procter & Gamble, cited the quality of services and collaborative approach from JLL that will allow P&G to “achieve efficiencies and meet our changing business needs globally.”

JLL was first hired by P&G in 2003. Since that time, the two companies have created service-delivery approaches and technology-supported platforms that improve best practices and help manage and increase real estate’s contributions to the corporation’s overall goals.

“Our focus is now on driving productivity and innovation at P&G through real estate portfolio optimization, total workplace design and advanced analytics,” said Joe Stolarski, JLL’s global account executive on the P&G account.  “We know we can deliver a step change in performance that will add value to the corporate bottom line.”

JLL’s corporate solutions group helps corporations improve cost, efficiency and performance of their national, regional or global real estate portfolios by creating outsourcing partnerships to manage and execute a range of occupier services. Last month, JLL expanded its corporate solutions division in the Northwest, where it named Michael Casolo to lead client services in that region. Casolo, based in Palo Alto, Calif., had been working with mid-sized clients since 2009. In his new position, he will also be focusing on larger, multinational clients, according to JLL.

The P&G extension for the corporate solutions division is just one of several real estate outsourcing contracts JLL has garnered in recent months. Last week, Duke Realty chose JLL to provide real estate services for its 1 million-square-foot office portfolio in Cleveland. JLL will be handling agency leasing, property management and project development services.  The firm was also picked to provide facilities management at The Howard Hughes Medical Instititute’s Janelia Research Campus in Loudoun County, Va. The 689-acre campus has more than 1 million square feet of space.

Regency Centers Corp. has just sold a 199,666-square-foot shopping center in San Pedro, Calif., to an affiliate of First Washington Realty Inc. — a private real estate investment, management and advisory firm — for $62 million. Studley represented Regency in the transaction.

The asset, Park Plaza, is a community retail center situated on 13 acres of land in the Western Avenue corridor of San Pedro. The retail mall is 95 percent leased to tenants including CVS, Petco, Office Depot and Bank of America.

Bill Bauman, executive vice president of Studley’s national retail group, called the shopping center “a well-positioned, prominently anchored asset in a core infill market.” He also noted that “more than 20 bids were received on the property, reflecting its history of strong tenant sales performance and stable rental growth.”

The greater Los Angeles area is expected to see significant motion in the retail market during 2012, according to a report by Marcus & Millichap Real Estate Investment Services Inc. “The Los Angeles retail market will progress up the recovery curve in 2012 as completions subside to one of the lowest levels on record and payroll gains boost retail sales,” the report noted before stating that “retailers in beach communities of the Westside Cities and South Bay will benefit from improved visitor volume, which will bolster retail and hospitality job growth and lend strength to existing operations.”

According to Studley, the buyer is planning to invest in “capital upgrades to further enhance the center and attract additional national tenants to the property.”

The shopping center was originally developed in 1962. The Regency Centers entity, Columbia Park Plaza L.L.C., acquired the property in 2001.

Image courtesy Flickr user coolinsights

U.S. consumers spent a little more in April than in March, but not much more, with the Census Bureau reporting a 0.1 percent month-over-month increase on Tuesday, adjusted for seasonal factors. Compared with April 2011, however, there was a 6.4 percent increase in consumer spending.

Factor out gasoline, the price of which has been falling in recent weeks, and retail sales were up 0.2 percent month-over-month in April, and also up 6.4 percent year-over-year. Take cars out of the consumer spending equation and the monthly increase in spending was exactly the same as the overall rate, 0.1 percent.

Department stores, clothing stores and office-supply stores all saw their sales edge down, though furniture and sporting goods retailers did better during April than March. One reason for the weak rise in spending after the relatively robust first quarter might be the weather. The theory is that unusually warm winter in most parts of the country might have brought sales forward that otherwise would have waited until the spring.

CPI Remains Unmoved

Separately, the Bureau of Labor Statistics said on Tuesday that the Consumer Price Index didn’t budge in April. Gasoline prices are moving down — prices at the pump dropped 2.6 percent during the month — but a lot of other consumer goods are eking out small increases, so on the whole things balanced out for the month.

Take out energy and food, and the “core” index for consumer prices was up 0.2 percent for the month. Consumers saw increases in shelter — that’s the tight apartment market at work — used cars and trucks, medical care, airline fares, new vehicles and apparel. Prices for all kinds of energy were down, not just gas, including heating oil and natural gas.

Compared with the same month last year, prices for all items were up 2.3 percent in April, the lowest annual change since February 2011. The index for all items less food and energy also increased 2.3 percent over the last 12 months, which was the first time since Oct. 2009 that the all-index hasn’t been more than the “core” index (without energy and food).

Homebuilders Feeling Better

Homebuilder confidence has reached its highest level since before the housing crash, according to the National Association of Home Builders on Tuesday, reporting that its housing market index, or HMI, has increased five points to 29. Each of the index’s components rebounded from declines in the previous month, with current sales conditions and traffic of prospective buyers both rising five points to 30 and 23, respectively. The component gauging sales expectations in the next six months rose three points to 34.

These are only relatively high numbers, however, since 50-plus still represents an optimistic industry. “While home building still has quite a way to go toward a fully healthy market, the fact that the HMI has returned to trend is a sign that firming home values, improving employment and low mortgage rates are drawing consumers back,” NAHB chief economist David Crowe noted in a statement.

Wall Street had another down day on Tuesday, probably still jittery with euro-worries, with the Dow Jones Industrial Average dropping 63.35 points, or 0.5 percent. The S&P 500 lost 0.57 percent and the Nasdaq declined 0.3 percent.