NEW YORK -- 24/7 is the key to investing in real estate in 2000, according to the 21st annual Emerging Trends in Real Estate 2000. That means focusing on cities that operate 24 hours a day, seven days a week.
Jointly published by PricewaterhouseCoopers and Lend Lease Real Estate Investments, in conjunction with Real Estate Research Corp., the forecast is based on interviews with a wide range of 150 industry leaders including investors, developers, analysts and academics.
A key theme of this year's forecast is the move back to the city. Interviewees selected the 24-hour megacities as the best investment markets for 2000 and the best markets on a risk-adjusted basis. San Francisco was the top-ranked city, followed by New York, Boston, Los Angeles, Washington, Chicago and Seattle.
The suburbs are losing their luster. In the current environment, no one can afford to sit still. All the old ways of doing business are being transformed, and to be successful, it is critical to anticipate change, Emerging Trends advises.
One of the biggest changes that's already occurring, according to the report, is the reduced need for office space. The technological revolution has spurred businesses to operate more "virtually," which has been changing how tenants use space and cutting into the growth in demand for office and industrial space.
Advice offered
Among the nuggets of advice offered to real estate investors and managers:
* Concentrate on the best locations. Twenty-four hour cities and prime areas that are expected to be redeveloped will be magnets for people and commerce.
* Focus on premium space; avoid commodity buildings. As demand for space moderates, the best regional malls and prime central business district office buildings in 24-hour locations will thrive and become more valuable while properties in secondary locations will lose value.
* Recognize suburbs that have peaked. Investing where there's growth will become more difficult as sprawl controls and congestion issues push population and commercial interests back toward the stronger 24-hour cores.
* Redevelop underused space in areas around those thriving 24-hour locations, which will generate premium returns through development strategies. Ripe candidates for multiuse projects include abandoned regional malls and underused manufacturing zones.
* Follow the baby boomers. There are 75 million boomers, and they're getting older. Their kids are leaving the nests, and retirement is looming. They're leading the move out of suburbia and back to the city, where they want easy-to-maintain apartments. They're also taking more vacations than their parents did, and by 2015 they will be swelling the demand for senior-living facilities.
* And don't forget their kids -- the echo boom. Computer-savvy, this generation will push for advances in virtual technologies and conveniences at home, in the workplace and when shopping. E-commerce will be a favorite retailing channel. This group has the potential to push the boundaries of how we make the most use of space in the next 25 years.
* Go overseas for opportunity investing. Maturing U.S. real estate markets with slowing growth trends will offer fewer development opportunities than they have. Capital market influences promise to smooth traditional boom and bust cycles, dampening big returns on cyclical market-timing investment. The best regions for opportunistic or enhanced returns will be found in less-developed regions, particularly Asia, Eastern Europe and Latin America.
* Take advantage of arbitrage opportunities in commercial mortgage-backed securities. Dislocations between capital market spreads and real estate fundamentals will offer sharp CMBS investors excellent opportunities in this fast-growing business, which could become global in the next decade.
Emerging Trends predicts next year will feature relative supply-demand balance in most property sectors and markets. Returns should level off around 10% to 12% for core institutional portfolios. Executives who were interviewed called the markets "stable," "mature," "boring," or "dull," as real estate has been eclipsed by the stock market's passion for technology and Internet companies.
Balance to continue
The survey predicts that 2000 will be a better year for selling than buying, but not much better. Prices and yields for most property types are expected to level off while deal cap rates will edge up slightly. While it might not be an exciting environment for deals, most observers believe the supply-demand balance will continue through the year, with little danger of a near-term downturn.
The downtown office sector remains the survey's No. 1 choice, but the multifamily apartment sector has rebounded, moving back to its traditional position near the top of the property rankings. Only retail and limited service hotels continue to cause worry.
For best investment bets, Emerging Trends suggests the following: buy undervalued, capital-starved real estate investment trusts at 20% to 25% discounts from net asset value; develop office buildings in 24-hour cities where capital is available; retain existing Class A offices in 24-hour cities, where values are likely to increase; acquire Class B apartments in markets where housing costs are high or rising, mainly in 24-hour cities; buy 'big box' warehouses in major distribution hubs that offer all of the loading and unloading features essential to industrial space.
The report's "good possibilities" include: hold fortress regional malls -- those multianchored centers that add value over time -- and buy neighborhood centers that are expected to be renovated and are near 24-hour suburban markets. It advises holding off on full-service hotels, where occupancies are slipping as new construction of these starts; suburban office prospects also have cooled, and the survey results suggest it's a good time to sell these.
The worst bets right now, according to Emerging Trends, are power centers, Class B and C regional malls, limited service hotels and 9-to-5 office markets.
Work styles to change
Emerging Trends also emphasizes that business' goal of reducing space related-costs involves the transformation of work styles. Many interviewees said while the office provides a place to congregate, they don't have to go in as often. So if technology is making office space less important, then business can do with less of it.
Warehouses are not immune to advances from the virtual world. Just-in-time inventory controls mean the growth curve for industrial space is likely to be reduced. Some observers say that between just-in-time and e-commerce the amount of both retail space and warehouse space could be reduced. In the immediate term, e-commerce will have a material impact on retail, accelerating the demise of weaker formats. Over time, retailers and manufacturers will sell more goods over the Internet, placing a premium on getting the best locations for their stores.
One international realty adviser predicts when today's nursery school generation grows up, they will be shopping on electronic aisles.
Suburbs under fire
Emerging Trends has been discussing suburban degeneration since 1995, and the trend continues. Even without such horrors as the Columbine shootings, it's generally agreed the once coveted suburban lifestyle is under stress. The problems of congested roads, problem schools and leaching urban ills are leading many suburbanites to simplify their lives and be closer to their offices.
While some suburban growth will continue in certain of the still-expanding Sun Belt regions such as Dallas and Phoenix, it's risky, according to Emerging Trends. The baby boomers' child-rearing years are over and Generation X prefers the excitement offered by the big cities.
As a result, investors need to distinguish between the various suburbs and focus on commercial markets with 24-hour facilities -- areas with convenient shopping, schools, entertainment, parks and transportation. Labor pool access will become increasingly important, because it will be hard to do business without back-office staff.
Opportunities will evolve at prime infill locations that are ripe for redevelopment as other areas deteriorate. It will be time to start from scratch and design communities that integrate residential, retail and office. It means going back to recreate the village offering an environment where people can work, play and live. The best suburbs can be expected to urbanize.
High-growth no more
Thanks to the prevalence of the new technology, the influence of the public markets on capital flows has become pervasive throughout the real estate industry. Discipline in the market is greater than ever, as a result. Now captive to market forces beyond its control, real estate is no longer a high-growth industry -- and next year is a pivotal point. Real estate has entered a new dimension. The market is a mature one, where investors are focusing on the tenants who lease the buildings -- "the virtual world's dot.coms and e-wannabes" -- as much as on the buildings themselves. "There is potential to make a lot more money on those tenants than on the real estate," said one interviewee.
Real estate nevertheless seems more relevant than ever as a solid income generator that provides additional upside from appreciation. And on a risk-adjusted basis it's a strong play for the year ahead. "The picture of the trophy asset is gone. Now we're just return-focused," said one acquisitions specialist. The challenge is to add value and find the opportunities that inevitably exist in private market imperfections. Bricks and mortar will stand up to the test; the right bricks and mortar, that is, and the right investment strategies.
