Real Estate Outlook 2011

It's a good time to take pause and assess the outlook for real estate over the next year. Below I have given my assessment of the outlook for commercial real estate and residential real estate. I have been very skeptical in the past as to how commercial real estate will perform as the Commercial Mortgage Backed Securities (CMBS) begin to mature en masse this year and peaking in 2012. Evidence is emerging that the CMBS servicers are becoming flexible by restructuring loans, extending terms, and reducing rates. If this practice is adopted across the board we could avert a crisis and now be at the bottom.

I am very upbeat on residential real estate. Today it is the most affordable time to buy a home in over four decades. I am also bullish on home building and believe it is a good time to begin projects that will deliver in the next 18-24 months. A look to the large homebuilders supports this claim as they have been busy accumulating land.

Commercial Real Estate Outlook 2011

Commercial real estate transaction volumes continue to be well off their 2007 peaks. 2010 did see a marked improvement in transaction volume over the anemic 2009 level of $55 billion to $115 billion, or a 109% increase. However at the 2007 peak, $522 billion of transactions were recorded, which means 2010 was 78% below, and 2009 was 90% below, the peak volumes.

Values have also taken a significant hit. The national average across all asset classes is showing a 42% decline in value from the peak. Certain assets are defying this statistic. With pent up demand from funds sitting on cash waiting on the sidelines some of this cash has been put to work chasing the highest quality properties, with the best addresses, and the best tenants. This has resulted in some premium properties actually trading at valuations at or near all time highs.

The multifamily sector has seen valuations increase dramatically also. There are a number of factors in its favor, namely high occupancy rates and cheap debt financing available compliments of the Government Sponsored Enterprises (Fannie & Freddie). With home foreclosures on the rise and prospective new home buyers still hesitating to step back into the market, the demand for rental apartments is extremely high.

What are the prospects for 2011? With vacancy rates at high levels and a slow jobless recovery in the economy, one might question whether 2011 will be a flat year or see further declines. According to Reis, Inc., the national average office vacancy rate is at 17.6%, and for retail it is at 10.9%. There are projections being made that 2011 will see another doubling of transaction volume to $230 billion with investors believing that we have now reached a bottom.

The outcome for 2011 rests firmly in the shape of the economic recovery and the extent that it creates new employment. Residential home building will have the most to gain from any increase in consumer confidence. I have speculated before that the looming Commercial Mortgage Backed Security (CMBS) maturities, which peak in 2012, will bring an avalanche of property sales as borrowers struggle to refinance or put more equity into their ownership structures.

I have questioned whether CMBS loan servicers will have the authority or mandate to restructure these loans like the banks have been doing. There is some evidence now emerging that the CMBS services are willing to restructure and play the "extend and pretend" game, and if that is the case across the board then we may be at the bottom in commercial real estate.

Residential Real Estate Outlook 2011

Residential real estate has seen its average values decline by 30% since July 2006, according to figures from the Standard & Poor's/Case-Shiller price index. We are approaching five full years of declining values, a phenomenon not seen before in the US. The cheap and easy lending standards of the boom years have contributed to our current woes, along with the oversupply of units when developers put up housing at break neck speed to keep up with demand.

Lending standards have returned to more conservative levels again, and rightly so, however there may have been a knee jerk reaction resulting in the current underwriting standards being too rigid. This has seen a huge upsurge in FHA lending, where higher loan to value levels and lower scores are tolerated. Ironically the poor lending practices of the past have got us to this point, while the conservative lending practices of today are making it difficult to breath any new life into the market.

Another major factor affecting the current market is consumer confidence and sentiment. It has taken a battering over the past few years and it will take an improvement in the jobs market to turn this around. Rising stock markets, record corporate earnings, and historically high corporate cash reserves will do nothing to appease a consumer who has become disillusioned with their own job security or future career prospects.

This may sound like a prophecy for further declines or at least stagnation in the market. However I believe we have bottomed in this cycle and are poised for increased values once the consumer sentiment has improved, probably upon evidence of an improving job market. Sure, we are likely to see some ups and downs in pricing over the next year, but the return to increasing values when it happens could turn quickly.

My reasoning for this is down to the increasing US population and the lack of new supply that has been developed over the past four years. The US needs 1.5 million units of new housing to be created each year to meet average demand. The population is growing at 3 million per year, representing 1.25 million households, and add to that an average of 250,000 demolished units per year, gives a requirement of 1.5 million units per year. 2001 was the first year of excess units, with 1.6 million being started, which rose each year until it reached its peak in 2005 of 2.1 million units. The unit starts over the past four years were 1.3 million (2007), 0.9 million (2008), 0.5 million (2009), and 0.5 million (2010).

We now have a situation where there is a cumulative deficit of new units of 1.3 million as a result of the decline in the new unit starts. This may sound crazy due to our current predicament of a slow market, short sales and foreclosures. My numbers tell the story of the average demand for new units over the past few decades. We are not seeing this demand play out right now as people have deferred their decision to acquire until they feel the worst has past. People in their twenty's and thirty's have returned to living at home with parents, moved in with friends as roommates, or they are renting, while they wait to see what comes of the market.

A counter argument to this is the huge inventory of foreclosures and shadow inventory of units yet to be foreclosed. However the people living in these units will enter the rental market until they have repaired their scores, or will have a family member take out mortgage financing on their behalf, and they too will once again return to the market. A foreclosed unit represents an addition to the supply, however the foreclosed property owner still needs a place to live and they will ultimately return to the market at some point.

Today residential property is at its most affordable in four decades. The National Association of Realtors (NAR) Housing Affordability Index is at its highest since their records began in 1971. We still have mortgage rates at extremely low historical levels. Now is a good time to get back into the market. If you are looking for an excellent residential mortgage broker or real estate agent to assess your options, I would be delighted to refer you to a trusted professional.