PwC RE Investor Survey: ‘Real Optimism’

Investors are positive about the industry's performance and outlook; all this despite rising interest rates.
PwC - Mitch_Roschelle
Mitchell Roschelle, PwC

PwC’s Real Estate Investor Survey for the third quarter has been released and the title says it all: “Real” Optimism Returns to the CRE Industry. Indeed, investors are positive about the industry’s performance and outlook; all this despite rising interest rates.

Investors’ sunny disposition in the face of increasing interest rates was one of the big surprises in the third quarter survey, according to Mitchell  Roschelle, partner, U.S. real estate advisory practice leader, PwC.

“Everybody views commercial real estate as being an interest-rate sensitive asset class, and I wouldn’t say that investors are cavalier about the increase in rents but they just didn’t view the uptick in interest rates as being something that was going to change their investment strategies,” Roschelle told Commercial Property Executive. “I would have thought that investors would be more freaked out about interest rates and they haven’t.”

Investors found plenty to be happy about in the third quarter. Multi-family properties, of course, kept everyone all smiles, with vacancy rates in the low 4-percent range. “Fundamentally you have a very low vacancy rate in multi-family, you have additions to supply in terms of new construction that are still a fraction of the pace of additions to supply that we experienced in 2007,  and we have an increase in household formations,” Roschelle noted.

Across the country, builders are building in response to the cry for more rental accommodations, but according to Roschelle, there’s no need to fear a glut. “We have 4.6 months of supply of single-family housing; before the crash we had 10.2 months’ supply of single-family housing. We don’t have a lot of supply of homes and we don’t have a lot of supply–based on that vacancy rate–of apartments, so we would have to wildly overbuild multi-family in order to really skew the vacancy rate and create overbuilding situations.”

It’s not conjecture; it’s experience. “Every other time in the 30 years that I’ve been in business that we’ve had a crash in the real estate market, it’s been a direct result of oversupply, Roschelle added. “The one thing we have right now is an undersupply. And we don’t have a mechanism in place from a lending or capital-raising perspective to fuel crazy development. So I don’t see a bubble in apartments.”

The industrial sector, warehouse properties in particular, commanded investors’ attention in the third quarter, according to the survey. And given that respondents anticipate a jump of as much as 10 percent in property values in the national warehouse market over the next 12 months, the sector will certainly continue to hold their interest. 

“Industrial has never been viewed as a sexy real estate investment; however, you have to look at the durability of the cash flows,” Roschelle added. “The stability and durability of the cash flows of industrial are what have been attracting investors to it. There is the proximity to highways, ports and rails and [other transit], so a well-located, well-leased industrial property is–forget about sexy, because it certainly isn’t–definitely getting investors’ attention.” 

But on a micro-market level, there appears to be something more than cash flow and proximity to transportation outlets that should be on industrial investors’ radar, and that is single-family housing. It has something to do with crown molding. Really.

“If we look at Florida, Arizona, Nevada–the three parts of the country that are seeing a resurgence in housing–one of the things we’re interested in is not regular warehouse space, but we may see a little resurgence in flex space,” Roschelle said. “In order for homebuilders to deliver product to customers efficiently, they prefabricate a lot of what is in the house. Even a $300,000 house somewhere in America has crown molding and other features like that because it’s those little finishes that get people to want to buy this homebuilder’s house versus that homebuilder’s house. In order to do that, they’re not cutting wood in the driveway; it’s all prefabricated and it’s been prefabricated somewhere in the vicinity so you don’t have a lot of transportation cost, which would add to the cost of the house.”

It’s been prefabricated and held somewhere like a nearby light-industrial facility, a flex space. “So we think we’re going to see a resurgence in flex space in those markets that are experiencing housing recoveries,” he concluded. 

The office market didn’t exactly have investors turning cartwheels in the third quarter. Recovery in the central business districts ranged from lively to lackluster and leasing remained sluggish in the suburbs. As Roschelle summed it up, “It’s the slowest grinding recovery.”

It’s slow despite the replacement of jobs that were lost during the Great Recession. Those jobs figures can be deceiving. “If you look at the numbers more closely, while there are a lot of office-using jobs that have been created–and I think roughly 60 percent of the service-sector jobs are going to be office-using jobs–there’s a lot of part-time and seasonal work in those service sectors so we haven’t really pushed the envelope in terms of increasing the demand,” he explained. “The other thing is a lot of space has gotten reconfigured to allow for more people to work in the same amount of space.”

Per the PwC real estate barometer, by the close of 2013, 50 percent of the U.S. office stock will be in recovery and 35 percent will be in expansion. By the end of 2016, 35 percent will be in recovery and 63 percent will be in expansion.

Investors have been making bets on office for the last two-and-a-half years, but they still remain cautious,” Roschelle noted. “But I truly think if we haven’t added supply and we continue to create jobs, you’re going to see rent increases in 2014 in the office sector.  We’re starting to turn the corner and the survey suggests there are many markets in the country where landlords think they’ll see 3 to 5 percent rent increases. I just think office [is the sector] you need to be the most patient with.”

While user demand and rental rate growth for office space may be tepid on average, investor demand for the top office assets is anything but. The price tags on Class A properties in the better-performing CBDs remained high in the third quarter. And despite the big dollar-signs involved, investors found fewer offerings of premier assets in premier markets compared to the beginning of 2013.

With regard to the real estate market in general, in addition to the mild reaction to rising interest rates, Roschelle saw something else unexpected in investors’ responses, something quite promising. “The optimism that investors have about the continuing recovery is much more real or authentic than it appears to have been in the past,” he said. “They’re investing in real estate because of the fundamentals and attributes in certain markets; they’re not investing in it because it happens to be a cash-flowing asset and it’s just delivering the yields that they want. That, I think is the big meaningful takeaway.”