While the credit crunch and economic uncertainty have caused investor anxiety and tighter lending standards, commercial real estate (CRE) remains comparatively attractive with solid underlying fundamentals, plentiful capital and sustained allocations. Deloitte recently released its 2008 capital markets Top Ten Issues report. The report provides insight about commercial real estate market trends, over the short and long term, through a review of critical issues, an examination of the industry’s core fundamentals and an analysis of underlying factors.

Executive Summary

Attractiveness Remains, But Can it Be Sustained?

Given the cyclical nature of the commercial real estate (CRE) industry, and the level of commentary coming from the press, it’s more important now than ever to take a closer look at key issues facing CRE in order to invest strategically. While the debate rages as to whether CRE will be “fine until 09,” or headed for more immediate challenges in 2008, the facts and related issues themselves tell a compelling story, especially as the CRE industry weathers the current credit crunch.

The goal of this tenth report of a series is to provide insight into where the CRE market is headed by taking a step back and reviewing critical issues, core fundamentals and underlying factors. These issues include the following:

1. CRE Returns Remain Enticing, Especially as Stocks Turn Volatile.

Cash may still be King, but CRE has its own crown now. Returns for both core private real estate and public REITs have outperformed stocks and bonds for more than five years. There is evidence that real estate returns are cooling, however, due to the ongoing credit crunch and the associated negative impacts on cap rates. Core private real estate continued to perform well in 2007, but may not have finished as high as 2006, and REITs have suffered in 2007 by any standard. The currently prevailing view is that returns will be significantly lower in 2008, based on declines in capital appreciation, which will only be partially offset by holding rent levels. Going forward, how will real estate returns hold up in comparison with the stock and bond markets, as well as alternative investments?

2. Recent Credit Crunch Preoccupies Markets, Including Regulators. While the absolute amount of CRE debt has increased substantially in the past few years, the current credit crunch effectively brought an end to the period of historically high availability of cheap commercial mortgage debt. The culprit in this case is the long shadow cast by the residential subprime phenomenon. While subprime grew out of residential real estate, the spillover effect has caused investor anxiety that has led regulators to intervene and lenders to tighten requirements for both residential and commercial loans. The fallout from the residential downturn caused CMBS spreads to widen significantly. Subsequently, commercial real estate deals began to be re-priced. The question is just how deep is this credit crunch, and how long will it extend?

3. Residential Real Estate Continues to Drag Economy.

Despite hopes of a rebound that many held early in 2007, residential market woes have worsened and continue to exert a negative influence on the economy, particularly in the financial services sector. Housing has yet to bottom-out, as evidenced by rising subprime defaults and delinquencies, declining starts, sales and prices and quarterly losses reported by major homebuilders. The Federal Reserve has taken action by adding liquidity and lowering rates, but some say it needs to do more. Pessimists believe it could be years before a turnaround. Where else will the subprime contagion spread to? How long will residential continue to impact CRE? How much longer will investor anxiety continue?

4. Economy Still Confusing and Contradictory.

While the optimistic “Goldilocks” view of the economy was prevalent during the first half of 2007, stock market turmoil caused something of a setback to this perspective during the second half of the year. The stock market is seen by many as a mirror of the economy itself, and the volatile performance of stocks has caused doubts about the direction of the U.S. GDP. The Federal Reserve had been on the sidelines for more than a year, but this changed recently. Talk of recession has intensified going into 2008, but do the numbers support it? If conditions worsen, will the Fed step in again and lower rates? How will their actions impact the economy? CRE??

5. CRE Capital Still Available, but Pausing and Shifting.

Despite rumblings that allocations would flatten (or possibly decrease) for CRE acquisitions, the flow of capital not only sustained but accelerated in the first half of 2007 before coming down to earth in the second half as the credit crunch developed. The result was a spike in deals fallen out of contract. With the credit crunch continuing and the stock market showing troubling volatility, will investors decide to stick with commercial real estate? Will CRE benefit from the recent stock market turmoil? ...

Download 2008 Real Estate Capital Markets Industry Outlook: Top Ten Issues

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Executive Summary
Issue 1: CRE Returns Remain Enticing, Especially as Stocks Turn Volatile 4
Issue 2: Recent Credit Crunch Preoccupies Markets, Including Regulators 8
Issue 3: Residential Real Estate Continues to Drag Economy 12
Issue 4: Economy Still Confusing and Contradictory 14
Issue 5: CRE Capital Still Available, but Pausing and Shifting 18
Issue 6: CRE Fundamentals Solid; Rent Increases Slow, Caps Rise 22
Issue 7: Domestic REITs Hit the Wall, as Global REITs Gain Acceptance 28
Issue 8: Global Synchronized Growth Encourages Global CRE Investment 30
Issue 9: Regulatory Concerns Heighten as Markets Globalize 34
Issue 10: Accounting Standards Converging 36

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