Cushman & Wakefield: Global Real Estate

Forget Spain for now, events in Greece over the next few days will be setting the tone for Europe for better or for worse.

Greek voters go back to the polls on Sunday and clearly face a tough choice, caught between a rock and a hard place.  Surveys have suggested growing support for pro-bailout parties but with no opinion polls allowed in the last 2 weeks of electioneering, we’re going in to the countdown blind.

Parts of the Greek property market have all but seized-up as the election has approached but if we’re lucky, the result could pull us back from the brink if it is seen as an endorsement of efforts to stay in the euro. Equally however it could edge us closer to what many see as an inevitable break-up.

Either way, we shouldn’t perhaps get our hopes up that the end of the problem is nigh. Uncertainty is not likely to fade any time soon and greater electoral tests may lie ahead in Germany and Italy.

A flight of capital may be seen if anti-bailout parties prevail on Sunday but whoever wins some let-up in austerity seems likely as the growing stresses in Greek business and society demand a response.  Nonetheless, a Greek euro-exit may not be a foregone conclusion, even though the potential for one or more members to leave at some point is greater than it seemed a few months back.

Contingency planning is clearly called for but when businesses consider this, they are often finding more questions than answers.  Perhaps the key property issue is what will happen to leases if the currency changes. No one seems to know but many have an opinion!

The safest assumption may be that those with most market power will prevail – and for now that means tenants given that Greece is a market with falling rents, rising availability, limited demand and tenant-friendly leases which can be broken at 3 months notice with just one month’s rent penalty, once passed the first anniversary.

At the same time, if the currency depreciates, so too will asset values for those looking from abroad.  Hence even though few leases have a clause to deal with currency change, it is not surprising that some corporates and investors are asking for one. More occupiers are also looking to renegotiate existing leases and in our opinion this will continue as the market and tenant needs change.

It has to be remembered however that Greek lease law offers a high level of security of tenure and those landlords with the luxury to choose will be wary of locking in too low a rent for the long term.  There also tends to be less flexibility to renegotiate in the shopping centre sector than elsewhere.   Hence the best advice for landlords and tenants is to consider each property and lease separately, be ready to act and renegotiate but not commit too far in to the future.

What is more, while all market players need to hunker down to wait out the crisis period, changing conditions will create an opportunity for some. However it may be a little while before some, investors in particular, have the confidence to act and in the near term, uncertainty will only put more investor emphasis on the safest, top prime global markets.

David Hutchings,  European Research Group, London

Hopes that the Eurozone debt crisis was on its way to being resolved have clearly been hit by recent election results and this continues to test the nerves of the property market, with the opening quarter seeing a fall in leasing and investment activity that was far from limited to just the most indebted markets of Greece, Ireland, Italy, Portugal and Spain (GIIPS).

Annual Change in Market Activity to Q1 2012:

Source: Cushman & Wakefield, RCA, Property Data and KTI

Hopefully this is only a temporary lull – and avoiding recession in Q1 was certainly a boost for the Eurozone – but Europe’s position is inevitably likened to being on a tightrope: with a fine balancing act required between austerity and growth, between short and long term needs and ultimately between purely national interests and the wider common good.

While there’s a lot of guesswork going on, the costs of a country leaving the Euro are not yet known but could well be huge for Europe and catastrophic for the country concerned. However while this seems to have been grasped by the authorities, the next steps may be decided on the streets not in Brussels  and the growth in support for extreme parties in many areas shows what a risk this is.

At the same time, it can obviously be dangerous for voters to have the illusion that there is much choice – as Greek voters may find out if they believe some of their politicians. After the hair cut “agreed” on Greek debt in March, it is likely to be some time – eg many years – before the private sector will again fund Greek public spending, whether in Euro’s or new drachma, and it will therefore remain reliant on the EU and the IMF.

Ideally the potential severity of this situation will lead to a willingness to compromise and in the first instance, we could see Greek voters and politicians recognising a need for austerity and in turn, in exchange for genuine reform, the troika and the markets could be ready to grant some relaxation to the depth of the cuts now planned, and not just in Greece.  Alongside this, the much demanded “plan for growth” could start to emerge – focusing on construction in many markets.

However whatever Greek voters decide next month, it remains clear that a resolution of the crisis will be neither quick nor easy.  For property markets, this has mixed implications – on the one hand risk aversion, limited growth and finance driven business failures will continue to hold back confidence. On the other hand, demand for core, stable assets and productive space to occupy will increase. What is more, sitting back and waiting for conditions to stabilise will be less and less of an option; occupiers and investors will need to react to the “new normal” of ongoing volatility and structural changes driven by technology and sustainability and, if we’re lucky, also by serious economic reforms.

David Hutchings, European Research Group, London

Optimism is Slowly Returning

Two important segments of the economy: consumers and small businesses, are getting more optimistic. In surveys released last week by the National Federation of Independent Businesses (NFIB) and the University of Michigan, the measures of confidence both reached their highest level since the recession of 2007-2009 began.

The NFIB survey measures business activity and the expectations of small businesses across the US. The respondents are asked about their opinion on the economy and their plans to hire and increase capital spending. Using the answer to these and other questions, the Small Business Optimism Index shows the relative level of optimism by small businesses across the US. In March seven of the 10 index components increased, with particularly large improvement in plans to hire and plans to increase capital spending. The overall index rose 2.2%, the largest gain in a year and a half and stood at its highest level since December 2007. The Index was at the exact same level a year earlier in February 2011 before it plunged as the European debt crisis emerged and financial markets dropped.

Small businesses are a vital component of the US economy. Businesses with fewer than 100 employees account for 98% of all the businesses in the US and 55% of all the jobs. Historically when the optimism index is rising US payroll employment is increasing. The recovery is small business optimism is a positive for the economic outlook. The Index is still below its expansion levels of the mid 2000’s, but it is also well off the bottom and heading in the right direction If it can be sustained, and barring any economic shocks this is likely, it will point to stronger economic growth in the second half of 2012 and 2013.

The University of Michigan has been surveying consumers for more than 50 years. Its Index of Consumer Sentiment is one of the most widely watched barometers of the vital consumer sector of the economy. The Index is calculated from the answers to more than 20 individual questions. These questions can be broken down into two types: those that relate to current conditions (are you better off today than you were a year ago?); and those that relate to expectations about the future (do you expect to be better off in the next 12 months than you are today?). The “Current Conditions” Index is about pocketbook issues and it tends to more closely track with consumer expenditures. The “Expectations” Index tends to be a leading indicator, pointing to the future direction of economic activity.

In the preliminary estimate of this Index for May (the final index will be released in 2 weeks), the Current Conditions Index reached its highest level since January 2008. For the first time in more than four years, consumers feel about the same as they did when the recession started. This improvement suggests that households will continue to increase their spending in the weeks and months ahead. Like the NFIB Index, the Current Conditions index is still far below the levels achieved during the height of the last expansion in 2004-2006. It too is likely to continue to gradually improve, barring another major shock, pointing to further spending growth in the future.

Optimism is slowly returning to the US economy in both the business and consumer sectors. It was here a year ago, only to be derailed by the European debt crisis. While that crisis is alive and well and could flare up again at any time, the past year has seen enough improvement in the underlying fundamentals, from healthier labor markets to rising equity markets (even with the recent declines, US equity markets are well above the levels of last fall) that it appears increasingly unlikely we will see a repeat of last year’s disruption.

Overall, the improvement in optimism suggest that a stronger second half is in store.

Small businesses are getting more optimistic

Consumers are feeling better as well

The office market in the Washington, D.C. Metro region was off to a slow start in 2012, with leasing activity down from last year at this time in both the Downtown and suburban markets. Negative absorption of 452,000 square feet (sf) in the District marked the second consecutive quarter of decreased absorption. The CBD submarket was responsible for most of this as tenants such as the Federal Housing Finance Agency (FHFA) and the Internal Revenue Service (IRS) either vacated space for other submarkets or downsized. At 13.1%, the CBD vacancy rate is at its highest level in 15 years.

The Northern Virginia market also contracted, due in large part to space being returned to the market by the U.S. Army, Air Force and other government agencies in Arlington County as a result of BRAC (Base Realignment and Closure) initiatives. Absorption was negative 1.2 million square feet (msf), with the Crystal City submarket contributing to about half of that. Vacant space in the Northern Virginia office market approached a level not seen since 2003, with 17.5% of its inventory recorded as vacant.

Suburban Maryland was the only jurisdiction to witness some positive market fundamentals.  Despite positive absorption, slow leasing activity in Suburban Maryland mirrored the rest of the region, coming in at about half of last year’s total at this time.

Renewals remained dominant, accounting for 38% of all leasing activity in the Metro region. In some cases, landlords are willing to renew tenants with up to 5 years left on their leases.  Tenants of all sizes continue to negotiate favorable lease terms including contraction and termination rights. The drive towards efficiencies and keeping costs under control has resulted in the “right-sizing” of all types of businesses: legal, non-profit, and … government.

The investment sales market in the District was fairly active during the first quarter, with nine closed transactions representing $979 million in total volume. The top three transactions were completed by foreign investors. With 17 office properties currently on the market, D.C. is poised to have an active 2012. Investment sales in the suburbs, on the other hand, nearly came to a standstill during the first quarter of 2012 with few properties changing hands.

Office market conditions in the region will remain lackluster into 2012, at least through the election, as government continues to downsize while tenants put off making decisions for as long as possible.  Activity will be mainly driven by lease expirations, although government contractors working for health or intelligence agencies may see some growth. Sectors such as technology, education and healthcare will also continue to grow, but not enough to absorb the excess supply of vacant space on the market.

Maria Sicola, Executive Managing Director of Research, Americas, and Paula Munger, Director of Research, Mid-Atlantic Region

After a cold and wet start, the sun came out at MIPIM to light-up the launch of our International Investment Atlas last week.

The Atlas looks at 2012 trends but also reviews the year gone by and as we commented, the raw statistics on 2011 make it look like a pretty good year – global investment up 14%, rents up 4.9% and capital values up 8.4%. In reality of course it was a year of two very contrasting halves and so far 2012 has continued the weaker pattern that blighted the year-end rather than reverting to the much more welcome form of early last year: when we had a market with improving equity and debt as well as more risk tolerance.

However, maybe it was the sunlight, maybe it was the free flowing hospitality, but I’d have to say the mood at MIPIM was better than last year and a lot better than many expected. There was of course an understandable fascination with debt but there was also something of a “can do, will do” attitude coming from a lot of investors who were ready to think more imaginatively to find opportunities – whether in new markets or by taking more risk in existing targets.

This was also reflected in the conclusions of our report and we expect more diverse patterns of investment this year, with a lot of local issues bubbling up to shape risk and growth rather than just the broad global trends that seem to have dominated since the Credit Crunch hit.

Occupiers however are still subject to some pretty broadly spread forces of course and it is changes in occupier needs rather than pure expansion which could be an early catalyst for much of the market, whether from tenants seeking space to tackle new markets, to cut occupational costs or to address structural issues such as sustainability or technological and demographic change.

Global Commercial Property Investment Volumes (excluding multifamily)

Source: Cushman & Wakefield, RCA, KTI and Property Data

In terms of investment activity, the Atlas forecasts a fairly flat year for trading meanwhile – but with something like a 20% increase in the second half of the year as confidence and the flow of opportunities increases. The report in fact concluded that while a return of better economic growth would be key to the strength of recovery, the most crucial point for the timing of that recovery will be confidence – and based on what I saw at MIPIM, that return of confidence may come sooner than we think!

David Hutchings, European Research Group, London

The US Labor Department reported this morning that the economy added 243,000 payroll jobs in January, the largest increase in employment since last April. In the private sector payrolls increased by 257,000, bringing total private sector employment growth over the last six months to 1.06 million persons. The unemployment rate declined to 8.3% from 8.5% in December. As recently as last August the unemployment rate was 9.1%.

The strongest growth was in the professional business services sector, where employment increased 70,000 jobs. Large increases were also reported in the manufacturing sector (+50,000 jobs), leisure and hospitality (+44,000) and education and health (+36,000). The government sector continues to shed jobs as states and particularly localities are forced to retrench under budget pressures. Office-using employment (made up of the financial, professional services and information sectors) increased 52,000 jobs, the fifth month in a row that these sectors have added more than 40,000 jobs. The last time that happened was from November 2005 to March 2006.

The decline in the unemployment rate is particularly encouraging. This data is obtained from the separate survey households (as opposed to the business survey that provides the payroll employment data) and that survey showed the number of people unemployed fell by 339,000 in January and has plunged by more than 1.1 million in the last four months. The labor force continues to grow, so people are entering the labor force and finding jobs.

The US economy is slowly regaining its footing after the interruption that started last spring. The employment growth of the last two months coupled with indicators of rising business and consumer spending (auto sales in January were the highest since mid-2008) are very positive. It’s still early and there are a number of important challenges facing the US economy including the resolution of European sovereign debt issues, the US budget deficit debate and the 2012 elections. But with corporate profits at record levels and household balance sheets in much better shape, the fundamentals are improving.

For the real estate industry there is nothing more important than employment. More jobs represent more demand for space. So a return to healthy job growth is the most positive sign in the last six months. Rising spending will also spur higher demand for manufacturing, warehouse and other industrial spaces. And, of course, higher consumer spending will help the retail sector.
We are encouraged by this report, however, as the chart below shows, the economy turned in a similar performance a year ago only to falter. We have been cautiously optimistic on 2012 and this report reinforces that outlook.

�

Recent events in Europe have been deeply destabilising but in time they could potentially lead to some quite welcome changes and could also produce some surprises.

Starting with the latest “solution”, a deepening of fiscal links and controls between Eurozone members, this has been widely criticised for a lack of detail and also because it fails to address key issues like the build-up of private sector debt and the lack of growth in the Eurozone.

In reality however one plan can’t solve all problems; the Eurozone needs a number of initiatives in different areas and bringing control and trust back to public sector finances can hardly be a bad place to start. In fact if the planned compact evolves more as a Eurozone fiscal policeman than a fiscal government, then it might be a welcome step forward.

What is more, current pressures may bring about other overdue changes to combat excessive debts and push through reforms. Indeed, whether the Euro collapses or endures, there will be a need for such reforms to be accelerated and for imbalances to be righted.

So on the “welcome” side we have the potential for reforms to actually get under way at long last. On the “surprising” side, we have the prospect of the Euro emerging as a much stronger currency once its structure is revised and improved.

More of a long shot perhaps, what about the potential for the UK to consider joining the Euro?  This may seem unlikely or even impossible today, but it could be a real winner for the Eurozone – helping to increase its size and importance, providing greater stability and boosting the Euro’s role as a global reserve currency.

So if getting the UK in would buy credibility – whatever certain French central bankers and officials might think –  what price would Eurozone governments pay to make it happen? Cameron’s decision to veto could ironically shift the balance of bargaining power in the UK’s favour and could offer the best way to safeguard London’s future.

Membership of the single currency would also have a powerful effect on UK trade and productivity by locking in a competitive exchange rate, reducing currency fluctuations, improving price transparency and possibly leading to greater capital market integration.

So could it happen? It may look unlikely to say the least but recent events should have shown us it would be dangerous to rule anything out – well nearly!

David Hutchings, European Research Group, London

As we approach the end of another year, the U.S. economy continues its measured recovery.  Gross Domestic Product grew at a 2.5% annual rate in third quarter 2011, bolstered by consumer spending, investment and exports, and a 1.1% year-over-year increase in non-farm payrolls that resulted in a net gain of roughly 1.5 million new jobs.

Despite the improvement, the recovery’s slow pace has had a noticeable impact on U.S. consumers.  Consumer confidence, as measured by the Conference Board, declined sharply in August to its lowest level since April 2009 and posted only a marginal gain in September, resulting in a third quarter average that fell below the level posted a year earlier.

By November, however, consumer confidence bounced back.  Although same-store retail sales increased by only 3.2% in November, its smallest increase since March, the recent back-to-school spending season was declared by some observers to be the strongest since 2006.  The holiday season began with a bang as well, as the “Black Friday” and “Cyber Monday” weekend set both traffic and sales records.

While the holiday season’s heavy promotions, deep discounting, and expanded store hours will undoubtedly affect margins and average selling prices, it remains unclear how impactful increased traffic and sales volumes will be on retailers’ bottom lines.  With holiday sales accounting for as much as 20-40% of their total annual sales, retailers will remain very aggressive throughout the holiday season as they compete for consumers’ limited dollars.

Economic headwinds continue to perpetuate the ongoing bifurcation of the retail market.  The gap between high income and low income households in the U.S. continues to grow while America’s middle class contracts.  This “barbell of prosperity” has implications for all retail categories from apparel to consumer products as the high end luxury and low end discount segments continue to grow and thrive while the middle market segment shrinks.

U.S. luxury retailers continue to be the beneficiaries of this growing bifurcation trend, evidenced by their strong same-store sales performance in November.  The luxury segment is being bolstered by strong demand and the weak U.S. Dollar that has attracted record numbers of foreign tourists, resulting in higher rents along urban high street retail corridors in U.S. gateway cities such as New York, Washington, DC and San Francisco.

The discount segment is thriving as well, as many U.S. consumers shift spending to “needs not wants.”  This trend will continue to have a positive impact on warehouse clubs, outlet malls and perceived value apparel retailers like Nordstrom Rack and TJ Maxx.  Notably, the outlet industry, which targets aspirational shoppers looking for luxury or higher-end items at value prices, will likely be one of the primary beneficiaries of tepid consumer confidence as it continues to capture a growing share of retail sales from other sectors.

On the real estate side, the retail supply pipeline is expected to remain at historic lows for the foreseeable future, which will continue to drive down vacancy rates, which now range from 5-6% in the Mall and General Retail sectors to over 11% in the Neighborhood and Strip Center product sectors.  According to Property & Portfolio Research (PPR), less than 10 million sq ft of new retail space is expected to deliver this year, well off the pace of 157.7 million sq ft delivered at the peak of the market in 2006.  Unlike the multi-anchor power centers and lifestyle centers that filled the pipeline in years past, the new, smaller pipeline will consist primarily of urban in-fill development or new-footprint big-box, single-tenant stores anchored by discount retailers such as Walmart, Target, and Costco.

Retail rent growth along well-established retail corridors in U.S. gateway cities will remain strong and buoyed by the performance of luxury tenants, while class A malls and well-located (high traffic) strip centers in urban in-fill locations with strong anchors are also expected to be above average performers.  Rent growth in second tier malls and neighborhood/community centers will generally remain flat before seeing modest improvement in 2012.

Looking ahead, a myriad of factors including lingering unemployment, ongoing stock market volatility, persistent uncertainty about the political climate in the U.S. and financial conditions in Europe will likely impede any significant improvement in consumer confidence levels in the near term, which will temper household spending and restrain overall economic growth through the remainder of the year and into 2012.

For a look at the trends that will affect retail real estate in 2012, download a copy of Cushman & Wakefield’s latest Business Briefing 12 Trends for 2012 at the Knowledge Center or at  http://cushwakeretail.com/trendwatch/.

Northern California, that is. What’s happening in the San Francisco Bay Area and Silicon Valley? Let me give you the short and sweet version.

San Francisco job growth was 1.3% through August and job growth was a whopping 2.4% in Silicon Valley.

This growth is not fake, fake, fake, like the dot.com era it’s real, real, real. Do these names sound familiar: Google, Sony, Twitter, YouTube, Apple and Microsoft? They are some of the firms driving the activity.

Leasing activity is up 30% in the region through the third quarter. In Silicon Valley over 6.0 million square feet has been leased year-to-date; 13% of the total inventory. Class A space in Los Altos is 100% leased! Silicon Valley leads the nation in venture capital funding capturing nearly 2 times that of the runner-up, New England (sorry Red Sox fans…)

Investors have caught on as well. Kilroy has made several acquisitions in San Francisco and the Canadian firm, Manulife has dipped its toes in the Bay too with multiple purchases.

What’s not to like? The Giants won the World Series in 2010, the 49ers are leading their division, demand is outpacing supply, the population is growing, the intellectual capital is world class and the quality of life is outstanding.

Y’all come back now – hear.

The latest Cushman & Wakefield Occupier Conference in London revealed new research, the Insight 500 survey, emphasising the negative impact global economic uncertainty was having on corporate confidence and decision making.  However, the conference was also warned by broadcaster Rene Carayol not to get too downhearted by overly negative media coverage. What is more, it was also notable from the Insight survey that people were much more negative about the wider economy than they were about their own business sector – with legal and life sciences the most optimistic.

Source: Cushman & Wakefield, Insight 500 Survey, 2011

Clearly it’s dangerous to just extrapolate wider economic woes across all industries. There are sectors and businesses which are more optimistic– if largely focused on opportunistic growth.

There is also a balance between those looking to increase revenues and market share and those looking at cost savings – with the former, interestingly,  more likely to be a retail or industrial company according to the Insight survey and the latter more typically an office based business.

In the short-term, a majority in the survey said they would be focussed on making the best use of the space they already had and avoiding increases to their fixed cost base. Looking forward, flexibility and future-proofing are key. However while 70% want to introduce more flexible working, 66% are also ready to target new markets, whether in Asia or closer to home. Moscow for example was picked as the top location for expansion in our recent European Cities Monitor.

In short there will be winners and losers in business and while only some property markets need to be ready to cope with increased total demand, all areas need to be ready to cater for increased demand for more efficient and more productive space.

David Hutchings, European Research Group, London