Cushman & Wakefield: Global Real Estate

Last week it seemed we had been saved from collapse as an outline deal emerged to tackle the sovereign debt crisis in the Euro zone but, at best, these gains have now been put on hold by Greece’s decision to hold a referendum on the package.

So if it was not clear before, it certainly should be now, there remains much to be done!  It’s worth noting however that the steps suggested would strengthen the European banking system and provide hope that sovereign debt would be brought under control.  A lot of the details are still to be agreed though, so even aside from the Greek dash to the polls, there was always going to be plenty of room for more grandstanding, volatility and disappointment.

The scale of the package has also frustrated some but there is a fine line to tread between putting enough commitment on the table and avoiding more moral hazard with bail outs.

With the haircut on Greek bonds for the private sector increased to 50%, this could help to stabilise Greece’s debt position fairly quickly – with the exchange of bonds planned for early 2012.  A “voluntary” write-down also avoids the dread “default” label. What’s more, with the “troika” to start continuous and on-the-ground monitoring of Greek progress, we have the first steps towards centralised fiscal control – and more is to follow with Italy under pressure for example.

Bank recapitalisation plans will also need to be in place quickly. Through support and balance sheet cuts, the 9% tier 1 capital ratio target is to be hit by next June. This will not help the flow of new finance for real estate but should help stimulate bank action and bank-forced sales.

Putting debt on a firmer footing does not mean that deleveraging in the public and private sectors can slow down. In fact it will only throw more attention on to the question of how we generate the growth needed to fund the debt we have.  Growth is therefore the next battle ground and this will require a rethink among many property investors who have been focussed of late only on income and income security.

Where will that growth be? What are currently considered “distressed” markets may have to reform most and those reforms may open the way for corporate growth and reorganisation that triggers more property demand. Longer term we also have the question of how much stronger Germany may become as the centre for a rejuvenated and stronger Euro zone?

Whilst it is too soon to judge now, taken together the measures being suggested may eventually be seen as a turning point in the sovereign debt crisis – once Greece and others accept the way forward. Indeed, an increase in risk taking by occupiers and investors could well begin quite quickly when the dust from Athens settles.  Firmer measures to finance the enlargement of the EFSF – possibly including China – could only help confidence recover more rapidly.

David Hutchings, European Research Group, London

Occupier and investor activity in the global property market largely held up in the third quarter – but what are we likely to see in the next few months?   Sentiment has certainly become more cautious, which is hardly surprising given the volatility of financial markets and the uncertainty most of us are feeling over the economy.  For quality real estate however, we may see more rather than less investor demand – with low interest rates not to mention quantitative easing and other stimulus measures boosting the appeal of quality property.

Not any market will do of course and we’re already seeing pricing for some non-core assets come under downward pressure.  What’s more, what was clear from our recent “Winning in Growth Cities” report was that investors are continuing their flight-to-quality and are flooding into core global cities.

Top 25 Cities for Global Property Investment (12 months to Q3 2011)

Commercial property, excluding development sites.

Source Real Capital Analytics and Cushman & Wakefield

New York attracted most investment over the last year but the top 25 globally took 54% of all investment.  According to Wikipedia however, there are over 6 million cities in the world – so for investors to focus more than half their money on just 25 tells us something about risk tolerance and a need for scale and liquidity. Nonetheless, if investors only focus on the biggest, they may be missing out on opportunities to get better diversification by targeting a range of markets.

But where? A whole range of factors above and beyond size and wealth go to make cities a success, ranging from classic business location priorities through to softer factors such as image.  Advancing technology may give us the freedom to work anywhere, but this is only serving to reshape the role of cities as a melting pot of people and ideas, with the winners those that have the densest network of skills, knowledge and learning but also the richest backdrop of culture, innovation and quality of life.

What’s more, the increasing range of cities competing and cooperating on the world stage should be seen as an opportunity for investors to refine their thinking on what is a prime and what is a second tier city and expand their effective investment universe at the same time – which must be helpful in today’s market given the huge focus we are now seeing on just a handful of cities.

David Hutchings, European Research Group

September 9, 2011

In every economic expansion there comes a point of inflection when growth accelerates because businesses are no longer able increase output with their existing staff. When that point is reached, employment growth accelerates.

In the current recovery which is now more than 2 years old, that inflection point was reached in the February to April 2011 period. Employment growth accelerated as businesses became more worried about losing sales than holding down costs and consumer spending was picking up speed. Then, a series of disasters hit. There were natural disasters and man-made disasters and together they brought the economy to a screeching halt.

Natural Disasters. The most important of these was the earthquake and subsequent tsunami in Japan. This event and the crisis at the nuclear power plant that followed it was a tragedy for Japan. It also created stress throughout the global manufacturing economy as many parts for goods produced throughout the world come from Japan. Supply chain disruption was especially evident in the motor vehicle industry. In the US motor vehicle sales plunged 11% from April to May as supplies were constrained.

There were additional natural disasters including tornadoes in the Southeast, flooding in the Midwest and most recently hurricanes in the Southeast and Northeast. When events like this occur, the immediate economic impact is a pause as households and businesses assess the impact. These natural disasters all played a part in causing the economy to weaken in the second quarter and employment growth to slow.

Man Made Disasters, The natural disasters of the spring and summer were exacerbated by ones that were man-made: the European debt crisis and the US budget deficit and debt ceiling debate. These political debates and negotiations caused businesses and consumers to become more cautious because it was unclear how the issues would be resolved and how the resolution would impact them.  Would taxes increase? Would spending be cut? Would the political leadership be able to come together and resolve the issues?

Unfortunately, for the most part these questions have not been resolved either in the US or Europe.

In an environment of uncertainty businesses and consumers have taken a wait and see approach. Not knowing what they face, they are holding back on all but essential spending. The result is the economic slowdown we are now experiencing. Demand from consumers and businesses is rising, but only slowly.

With the impact of the natural disasters, particularly Japan now fading, it is the man-made disasters that are having the greatest impact on the economy. They have reduced confidence and put a damper on the recovery just as it was taking off.

Ken McCarthy
Senior Economist, Senior Managing Director, Research
Cushman & Wakefield

Office-using employment is definitely booming in San Jose, Dallas, Seattle, and Los Angeles.  Overall job creation rates remain strong in Dallas, Orlando, Suburban Maryland, and Houston.

Technology, energy, manufacturing and trade sectors have all been staffing up, although the rate of growth may still be below par in some of our major metropolitan areas like New York, Chicago and Boston.

If you’re just looking at net new positions created over the past twelve months through 1Q11, these are the top 10:

Dallas, TX                         2.3%                    64,030 jobs

New York, NY                    1.0%                    51,930 jobs

Houston, TX                      2.0%                    49,930 jobs

Chicago, IL                        1.2%                    42,870 jobs

Washington, DC                 1.6%                    38,430 jobs

Los Angeles, CA                0.7%                    25,430 jobs

Seattle, WA                        1.8%                   23,970 jobs

Boston, MA                        0.9%                   22,170 jobs

Pittsburgh, PA                  1.8%                   20,470 jobs

Orlando, FL                         2.1%                   20,370 jobs

In terms of year-over-year growth rates in total nonfarm payrolls, here are the top 10:

Dallas, TX                                          2.3%      64,030 jobs

Orlando, FL                                        2.1%      20,370 jobs

Bethesda, MD                                     2.0%      11,270 jobs 

Nashville, TN                                      2.0%      14,730 jobs  

Houston, TX                                       2.0%      49,930 jobs

San Jose, CA                                      1.9%      16,100 jobs

Pittsburgh, PA                                     1.8%      20,470 jobs

Bridgeport-Stamford-Norwalk, CT            1.8%        7,340 jobs

Seattle, WA                                        1.8%      23,970 jobs

Washington, DC                                   1.6%       38,430 jobs

In terms of growth in office-using employment, here are the top 10:

San Jose, CA                                        3.1%         6,590 jobs

Dallas, TX                                            3.1%      23,960 jobs

Seattle, WA                                         2.9%       11,140 jobs

Los Angeles, CA                                    1.9%        28,490 jobs

Detroit, MI                                           2.7%          4,160 jobs

Salt Lake City, UT                                 2.6%          4,450 jobs

Santa Ana-Anaheim-Irvine, CA                 2.6%          9,700 jobs

Manchester-Nashua, NH                          2.5%          1,250 jobs

San Diego, CA                                       2.3%          7,580 jobs

Nashville, TN                                         2.1%          3,730 jobs

So things are definitely improving in some markets!

At a time when retail sales in much of Europe are failing to stage the kind of recovery hoped for and consumer sentiment is lagging that seen in corporate Europe, it may seem odd that property investors are pouring money into retail rather than office or industrial property

Investment by Sector in EMEA

Cushman & Wakefield, European Research Group

 The mere fact that more stock has come available in what is typically an undersupplied market is obviously important but retail investment surpassed offices for the first time on record in Q1 2011 and while offices saw a big fall in activity in the opening quarter, retail went from strength to strength and investment in the year to March, at €41.4bn, was over 50% higher than a year earlier (EMEA Property Investment Report Q1 2011). 

So what are investors seeing – opportunities for growth, for income or for security? Arguably a bit of each although aside from a handful of markets, sales turnover will be fragile in the short term even if April was better than expected overall.

 A lot of investor demand is for large lots and the release of more shopping centers in markets like Sweden, Germany and the UK has and will continue to boost investment. At the same time, there is better demand for unit shops, which in key cities are a main focus for new retailer demand, and for food stores, seen as a sector with stability but also long term potential in the best locations. 

While the best underlying tenant demand and rental performance may be seen in the office and parts of the industrial market,  investors are clearly looking beyond short-term supply-driven cycles and are focusing on retail for greater long term security and lower volatility. What is more, investors are taking comfort in the fact that from a long term perspective, prime yields in most markets offer historically fair value. They are also seeking to focus on areas offering defensive characteristics or those aligned to future retail growth trends or with active management potential. Time will tell whether they are right!

David Hutchings, European Research Group, London

So the ECB has now joined others such as Poland and Sweden in raising interest rates to combat inflation.

Some fear that this may threaten what is clearly still a fragile economic recovery. In our view however it is unlikely to have a significant short term impact on growth. For one thing it has been widely expected and sign-posted – one of the more appreciated hallmarks of ECB moves!  

Equally, it needs to be remembered that increases in the policy rate should be offset to some degree by a fall in bank margins. Over recent times the spreads between policy rates and the rates at which banks actually lend have been falling but they are still historically high. We may not see a return to the margins typical before the crisis, with banks now reliant on more expensive retail rather than wholesale funding and the stricter capital adequacy requirements of Basle III impacting, but a steady fall in risk aversion and increased competition should still result in a further fall in lending margins.

The spread between ECB policy rates and commercial lending rates

Cushman & Wakefield, European Research Group

 What’s more, market expectations that EZ rates may climb 100-150bp in the next year may yet prove too aggressive, with a more cautious pattern of increases just as likely.  However, while policy tightening may not have the impact some fear, it will have more adverse effects on some. Eurozone countries who are struggling with excess sovereign and private sector debt will not welcome the increase for example but it will also raise tough questions for countries outside the Eurozone who can leave rates unchanged and hence gain a currency advantage but may also risk the sustainability of their debt burden for those carrying an excess of foreign currency debt.

 Overall, while the impact will not be uniform and interest rate increases, however slow, will hit borrowers, they will also signal that we are heading back to more “normal” times.  And perhaps that return to normality will be the biggest boost for confidence and activity that we can hope for!

David Hutchings,   European Research Group, London

So as the dust settles on another MIPIM, what messages did it send out?

On the whole, I would say positive ones. Attendances were up 5-10%, (despite a couple of high profile no-shows!) and the mood more upbeat, with even Dr Nouriel Roubini finding some “upside risks” to discuss in his keynote speech on the global economy.

Roubini is not alone in asking whether the mood was one of glass half full or glass half empty but as my 10 year old son pointed out to me, the real question is not whether it is half full or half empty, but what is it full of!? This would be a worthwhile point to have put to the MIPIM crowds as they talked of “increased activity” and “brightening” outlooks. What are they full of? Hope, proof, bluster or too much rosé?!

A shortage of stock and debt finance may well hold back the investment market despite rising demand but the analysis in our Global Investment Atlas, released at MIPIM, is more hopeful, pointing to a 5-10% increase in trading activity this year and the same in prime rents as occupier markets stir.

A lot of global gateway cities are already reporting falling availability and at least a stabilisation in rents, with many seeing growth returning, notably emerging markets in Asia and Latin America but also in Europe, with Russia leading the way.

What is more, while 2011 has started slowly in some areas of EMEA and the UK mood is perhaps more circumspect than some others, tenant demand for quality, well-priced space in all sectors has shown either resilience or growth. Indeed, while occupiers and investors should be aware that the recovery will be neither smooth nor evenly spread, it is still a recovery and it is happening!

David Hutchings,  European Research Group,  London

Remember the “double dip”? Less than six months ago there was such uncertainty about the sustainability of the economic recovery that many feared the US would fall back into recession. The Federal Reserve was so worried about the ability of the economy to grow that board members let it be known the central bank would purchase hundreds of billions of dollars in Treasury securities to ensure that the recovery is sustained. This week Federal Reserve Chairman Bernanke indicated that the Fed may not have to make all the purchases they planned.

A year ago, I was saying to clients that the economy would add about 1.0 million to 1.5 million jobs in 2010 and the reaction was skeptical. Many did not think the recovery would be that strong. Today, we look back at the past year and indeed the economy added a million jobs and it is considered a disappointment. After US GDP increased at a 1.7% annual rate in the second quarter and 2.6% rate in the third quarter, the consensus just a few months ago was that the economy would continue to grow slowly in 2011. Today forecasters are racing up revise their forecasts upward. I wouldn’t be surprised to see US GDP growth of 4.5% in 2011 with payroll employment growth somewhere in the 3.0 million range.

The US economy is about to shift into high gear. Growth is accelerating, employment growth will follow. This is being driven by corporate profits, which are up 65% from the recession low in late 2008. To continue to grow profits firms are shifting focus-from holding back spending and hiring to reduce costs to increasing spending and hiring to increase revenues.

This shift will have a major impact on the commercial real estate industry. More jobs, more demand and stronger spending will boost occupancy across the board. The result will be lower vacancy and upward pressure on rents. If there is going to be a surprise in 2011 it will be that the economy and the commercial real estate market is stronger than expected, not weaker.

Profits are back to pre-recession levels

Ken McCarthy
Senior Economist, Senior Managing Director, Research
Cushman & Wakefield

Airports around Europe may have ground to a halt this month as poor weather and delayed flights impacted, but it’s been a more mixed picture for retailers across the region. Even in those parts of northern Europe most affected, (for once it isn’t the south which is suffering), most retailers are hoping this will only be a disruption not a disaster.

The worst hit market has been the UK, where the “wrong sort of snow” and cold weather (surprising in winter) brought travel chaos and dented what had been a promising start to the festive trading period. Weather permitting, the Sales period into January could be busy but this will be cold comfort for those retailers who have to slash margins to try to make up for lost turnover.

Seasonal fluctuations aside, Europe’s retail market has actually fought back well from the collapse in sales seen in 2008/9, but this rally stalled back in October – not when the first flakes of snow fell in November. Set in an historic context this was certainly disappointing. Over the last 10 years October has been one of the strongest trading months. However trends vary market by market and also tend to be highly volatile. Hence we know we can’t generalise too widely. Germany for example saw sales leap over 5% in October and Russia by nearly 4%.

European Retail – Back from the Trough
All Europe averages, Eurostat

Cushman & Wakefield, European Research Group

What is more,  the trend for the year overall has been relatively good and on and off the record comments from retailers have tended to be positive, particularly from Value but also some Luxury brands. Hence while November’s figures are likely to be weak – it’s traditionally a poor month and adverse weather didn’t help – further snow aside, the prognosis for December outside the UK is actually pretty good. The worry must be more that Santa will be spending a lot more time in some countries than others and that the hangover in 2011 may take longer to fade than usual – so enjoy the holidays, while and where you can!

This latest recession took an especially large toll on the U.S. Industrial markets. While the overall economy lagged with a 3-4% contraction, the Industrial Production Index (production excluding technology) showed a peak to trough drop of 18%. This monumental drop in the industrial markets has had a drastic effect across all transportation sectors and modes.

Although transportation took one of the largest hits throughout this recessionary period, the industry actually has a lot to look forward to. As steep and dramatic as the downturn was, the industry is showing strong signs of recovering at an equally impressive pace – however the recovery has just started and there is a long way to go.

Rail, which showed double-digit declines for all Class-1 railroads in 2009, is experiencing substantial recovery. While volumes have not yet returned to the peak volumes experienced in 2007, key indicators are all pointing towards a return to sustainable growth in the near future. One very positive sign is the broad base of the recovery, with 18 of the 21 rail commodity subsectors expanding over the last year.

In recent history, U.S. ports have consistently expanded at 7-8% per year. In 2009, U.S. ports experienced their first ever downturn, with total TEU volume dropping 9%. This drop was short lived, and based on the strong YTD performance of the major ocean carriers, we are projecting the sector to return to its standard growth rate of 7-8% in both 2010 and 2011. So far in 2010, container volume for imports and exports has expanded at 15% and 10%, respectively. This imbalance is very surprising and is something that we will continue to monitor to see if the trend continues.

Also bolstering the future of the shipping industry is the ongoing project to expand the capacity of the Panama Canal. This project will open East Coast ports to opportunities to handle larger ships coming from Asia, thus expanding potential container volume. In preparation, many East Coast ports are improving operations, dredging channels and modernizing their terminals.

The trucking industry is also recovering at an impressive rate, but several external pressures will need to be addressed before we can fully understand the future of the sector. Concerns over driver shortage, artificially low prices, uncertainty in fuel prices, road congestion, and other factors are causing some experts to question where trucking’s market share will end up, especially with the increased competition from rail and short-sea shipping. Despite these challenges, prices are on the rise (6-10% YTD) and trucking continues to be responsible for 4 of every 5 movements of goods nationally.

Now how does this recovery in the transportation industry affect your supply chain? As transportation prices rise, there are three major impacts to consider. First, service levels become harder and more expensive to maintain. Second, distribution freight consolidation has less value. And finally, global sourcing and off-shoring becomes less attractive. Real estate trends that we are seeing in response to these impacts include: increased inventory levels, the deployment of staging/storage space closer to customers, and an increase in domestic sourcing and manufacturing.

As the times continue to change, shippers will have to be even more cautious, implementing both tactical and strategic measures to stay ahead of the curve. Now is the time for anyone moving goods to look at your supply chain and ensure you are well-positioned to remain competitive in the midst of the changing transportation environment.