HALFWAY THROUGH THE YEAR, Enrique Wong has completed just seven deals — about half of what he did during the first six months of 2001. Investors, owners and brokers across the U.S. can relate to the Encino, Calif.-based Marcus & Millichap apartment broker's situation. Like Wong, they know there are deals that could be done — there's plenty of money to be put to work and, in most property classes in most markets, there is ample inventory of real estate for sale.

But the market has seized up as buyers and sellers stare each other down across the negotiating table. Buyers are looking for lower prices to sustain cap rates on properties that are generating lower returns and sellers are holding out for better pricing, convinced that the economy is about to rebound and their price demands will be justified. Unless somebody blinks soon, 2002 will be the fifth consecutive year of shrinking investment sales, according to information compiled by Chicago-based LaSalle Investment Management.

In Wong's case, he has received four to five offers on each of the seven deals he has closed in 2002. Among those deals, six went for the full asking price, while the seventh property sold for 1.2% below the asking price.

In the first four months of 2002, the dollar value of commercial sales dropped 28% compared with the same period in 2001, according to New York-based Real Capital Analytics Inc. (please see chart on page 20). Real Capital, which tracks deals valued at $5 million and up, says that the total value of transactions in office, industrial, retail and multifamily properties fell to $18.7 billion from $25.9 billion. In the beleaguered hotel sector, where room rates continue to fall, sales have dropped off drastically. Only 61 buyers stepped up to the plate in the first quarter vs. 193 in the first quarter of 2001, a 68% drop, according to The Hospitality Research Group of PKF Consulting in Atlanta.

There's no mystery why hotel buyers are leery. Although the industry has come back some from its post-Sept. 11 plunge, the travel business is still depressed. The average occupancy rate fell from 62.1% in the first four months of 2001 to 57.2% in the same time period this year. The average daily room rate (ADR) is down 4.6% to $84.71, while RevPar (revenue per available room) is down 8.6% to $48.41, according to Hendersonville, Tenn.-based Smith Travel Research.

While the soft economy has complicated dealmaking, the bid-ask gap began to widen — and deal volume began to fall — while the 1990s boom was still going strong. Sales peaked in 1997 with $64.5 billion in private and public capital flowing into real estate investments. In 1998, sales slipped to $46.1 billion and by 1999, the volume fell to $29.6 billion. Then, buyers began sitting on their wallets because they figured the high rents and superheated demand for space could not be sustained. In 2000, volume fell still further to $18.8 billion, according to data compiled by LaSalle Investment Management.

“The slowdown reflects uncertainty in the market and a pretty significant gap between the bid and the asking price,” says George Hauser, CEO of Principal Capital Real Estate Investors in Des Moines, Iowa. In some cases, the differences between bid and asking prices at the end of the year were as much as 20%, he adds. As a result, many owners opted to take advantage of low interest rates to refinance and pull equity out of properties rather than sell in the current climate.

The bid-ask gap varies widely across property sectors and individual markets. No surprise, the biggest gaps are in the most troubled markets. “Definitely the softness in the office sector, the result of a lot of available space, has made investors more cautious,” says Dan Carr, a vice president in the Kansas City office of CB Richard Ellis. Vacancies in Class-A suburban space in Kansas City reached 19.49% in the first quarter. Bids are coming in at about 8% to 10% below the asking price compared with bids that were 4% to 5% lower last year, he says.

Generally, the price gap has been less pronounced in the multifamily and industrial sectors due to continued investor demand for those property types long considered to be safe havens in times of recession, notes Timothy J. Welch, executive managing director at New York-based Cushman & Wakefield Inc.

Aggressive buying is certainly responsible for driving prices higher in the apartment sector. “We are finding a limitation of available properties and a very competitive environment on those deals,” says David Levin, executive vice president of acquisitions at The Laramar Group in Chicago. This year, the Laramar Group plans to invest about $200 million in multifamily properties.

And dealmaking in retail properties has been relatively lively. One reason: the sector had already been hit with bankruptcies and other problems before the recession took hold, so the gap between buyers and sellers in the retail space has not widened as much as it has lately in the hotel and office sectors.

Retail vacancies increased slightly from 6% in the first quarter of 2001 to 7.1% in 2002, according to New York-based Reis, which tracks approximately 1.3 billion sq. ft. of neighborhood and community centers. Net absorption during the first quarter was negative 34,000 sq. ft. compared with positive absorption of 5 million sq. ft. during the same period last year. The effective rental rate rose nominally from an average of $15.17 in first-quarter 2001 to $15.20 in first-quarter 2002.

“Retail is very strong with a lot of positive attitude on everything from single-tenant properties to regional malls,” says Harvey E. Green, president and CEO of Marcus & Millichap. Despite high-profile bankruptcies such as Kmart, sales volume among national retailers has been better than expected, he adds. A decline in construction activity also should help stem rising vacancies.

“The retail sector has been doing well largely due to the strong consumer rebound that most folks didn't expect,” says David Shulman, managing director and senior REIT analyst at Lehman Brothers in New York. Retail REITs have been posting strong returns with a total year-to-date return of 9.06% as of March 28.


Across property types, “the most challenging issue for buyers and sellers today is determining what is an acceptable rate of return,” says Hauser of Principal Capital Real Estate Investors. Economic uncertainty makes the process more difficult. Office owners, for example, still come to the table with worksheets that include a 3% increase in annual rent. Buyers, on the other hand, are looking at rising vacancies and falling rents in many cases and factoring in no increases.

Sometimes sellers do acknowledge that falling rents mean they can't get the price they would have gotten a year ago. A major REIT recently shelved plans to sell two Atlanta apartment properties because of market conditions. Landlords across the region are giving concessions, including three months free rent, to bring in new renters. Even so, vacancies are expected to reach 8% by year's end. “The income fell off, and the REIT was afraid it couldn't get the sale price it wanted,” says Chris Spain, a senior director at The Apartment Group, a Cushman & Wakefield Co. in New York.


Some major properties are coming to market, and if the deals get done that could send an important signal to buyers, sellers and investors. One is the 446,864 sq. ft. Southdale Office Centre in the Twin Cities that likely will test investor appetites. The Class-B suburban office building is listed at $47 million, or $105 per sq. ft.

Pricing is consistent with recent sales, but it yields an aggressive cap rate of 9.27%. Comparable deals in recent months have traded at approximately a 10% cap rate, but getting a buyer to settle for that rate in a deteriorating market may not be easy. Class-B vacancies in the southwest submarket where the building is located reached 15.7% at mid-year. Net rents for Class-B space in that submarket have been flat, with average net rents dropping slightly from $12.12 at year-end to $12.04 at mid-year.

“In light of the still strong demand for institutional-grade property, we don't see it as an aggressive price,” says Pete Rand, a senior vice president at Bloomington, Minn.-based Welsh Cos. Rand had already received a half-dozen calls from interested buyers prior to the official release of sales information in mid-June. Rand is marketing the property on behalf of Dahlia Properties Associates, a subsidiary of New York-based Devon Properties Inc.

If the Welsh Cos. can get full price in this environment, it will be an accomplishment. The office sector continues to reel from the effects of corporate downsizing — with falling occupancy rates and a glut of sublease space putting downward pressure on rents.

“Clearly it has been worse than expected,” says Robert Bach, national director of market analysis for Grubb & Ellis Co. in New York. Office vacancies jumped from 8.6% in first-quarter 2001 to 14.7% in first-quarter 2002, according to Reis, which tracks an inventory of approximately 3.2 billion sq. ft. (see NREI's June 2002 issue). Net absorption during the first quarter of 2002 was negative 24.4 million sq. ft. compared with negative 4.2 million sq. ft. during the same period last year. The effective rental rate also declined from an average of $26.04 in first-quarter 2001 to $22.72 in first-quarter 2002, according to Reis.

Bach expects national office vacancies to top out north of 16% this year followed by a period of slow but improving conditions beginning in 2003. The recovery will be lengthy, Bach believes, due in part to the slow rebound in the economy. “Companies are very hesitant to hire people until they feel more comfortable with the sustainability of business and cash flow,” Bach says.

Despite softening market conditions, sale prices during the first half have held firm across many markets. “Most investors believe that even lower rates of return on real estate stack up very well against alternatives in the broader capital market such as stocks, bonds and offshore investments,” Hauser says.

Even a 10% return on real estate compares favorably with the yield on five-year Treasuries, for example, which registered 4.80% in mid-June. The low cost of capital also makes lower cap rates more palatable for investors who plan to hold properties for a lengthy period, he says.

If there's a bright spot for dealmakers, it may be in the industrial sector. Investors' appetite for industrial space combined with fewer properties available for purchase has pushed sale prices higher, prompting a decline in returns. Expected rates of return have dropped 50 to 100 basis points in the past year, yielding average returns of 9.25% to 9.75%. Eighteen months ago, a 200,000 sq. ft. building near Chicago's O'Hare Airport — one of the largest industrial markets in the U.S. — would have produced an expected rate of return of around 11%. Today, the same building would yield a return of about 9.5%, Hauser says.

Across the country, vacancies in industrial properties reached 8.7% in the first quarter. However, construction has also slowed. Currently, 57 million sq. ft. of industrial construction is under way compared with 72 million sq. ft. under construction on the office side, according to Grubb & Ellis.

Another relatively bright spot is in multifamily — despite some regional problems, such as in Atlanta. Across the nation, vacancies rose from 3.2% in the first quarter of 2001 to 5.7% during the first quarter of 2002, according to Reis, which tracks approximately 7.5 million units.

Net absorption during the first quarter was negative 47,583 units compared with positive absorption of 12,086 units during the same period last year. The effective rental rate dropped from an average of $870 per unit in first-quarter 2001 to $853 in first-quarter 2002, according to Reis.

Even with falling returns, however, there is plenty of investor interest in multifamily properties, says Green. “Demand for apartments is as strong as I have seen it since the mid-1980s,” he says.

Indeed, Levin of the Laramar Group says he lost out on a portfolio of 800 apartments in southwest Florida, when his bid fell 10% short of the $40 million purchase price. Laramar's bid would have yielded an 8% return. “There are buyers out there who are willing to take a lower return, or who are anticipating a stronger recovery, which in turn allows them to offer a little more on the asset,” Levin says.

Apartment cap rates have dropped about 25 to 50 basis points in recent months. Cap rates for Mid-Atlantic properties average about 7.5% compared with 8.5% in the Southeast, says Spain of Cushman & Wakefield.


Inevitably, the dealmaking logjam has to break — there's simply too much money waiting to be put to use. “Many buyers who just have not gotten comfortable in adjusting down expectations have a lot of money to invest,” Hauser says. However, that is likely to change in the coming months as more investors get back in the game. As the broader stock market continues to flounder, institutional and private investors alike are expected to earmark more capital for real estate in coming months.

Meanwhile, individual investors are putting more money into REITs. “Public real estate securities continue to be a wonderful investment with wonderful yields,” says Bruce Schonbraun, managing partner of Schonbraun Safris McCann Bekritsky & Co, a real estate consulting and accounting firm based in Roseland, N.J.

With all that money available and interest rates remaining low, there are signs that some buyers are ready to blink — and pay the prices that yield lower cap rates. New York-based Lend Lease Real Estate Investments is altering its anticipated rate of return for the $2 billion it expects to place in real estate acquisitions this year.

“We just don't see the opportunities to generate the same returns that we were able to get four or five years ago,” says Jerry Barag, chief investment officer at Lend Lease. A year ago, Lend Lease expected returns in the 10.5% to 11.5% range. These days, those returns have dipped 50 basis points or even more in some cases, Barag notes.

“The demand for real estate is extremely high, the amount of capital for real estate is very large, and the debt available for real estate is very, very good,” says Green of Marcus & Millichap. “Cap rates are still holding, and if anything they have decreased in certain markets because of the desirability.”

Pent-up demand across the property types is likely to push transaction volume higher during the second half of the year, says Kevin Haggarty, executive managing director in the Capital Advisors Group at New York-based Insignia/ESG Inc. “We are seeing a definite uptick in the second quarter, mainly because buyers have come to their own conclusion that the market isn't going to go down much further.”

“Activity has absolutely picked up in the last 60 days,” agrees John Cannon, senior vice president/managing director at GMAC Commercial Mortgage in Horsham, Pa.

“We have seen some activity in segments of the market such as hospitality and healthcare that have bottomed out,” Cannon says. “In general, the mood is better, and we are starting to see some sales.”

Welch at Cushman & Wakefield also is upbeat. “Buyers are contacting us consistently, and I think 2002 is going to play out pretty well in our part of the industry,” he says. Cushman & Wakefield accounted for $10 billion in deals domestically in 2000, but the volume dropped to $6.5 billion in 2001.

Even though the firm's brokers closed just $2 billion in transactions at mid-year, Welch is boldly predicting a comeback in the second half due to a pipeline that has climbed to $8 billion. And the deals will flow from that pipeline when the buyers and sellers narrow the gap that separates them. That's the theory, anyway.

Contributing editor Beth Mattson-Teig is a Minneapolis-based writer.


The number of major hotel sales — defined here as transactions of $10 million and higher — dropped significantly in the first quarter of 2002 compared with the same time period last year. HVS International attributes the decrease in transactions to the economic downturn and repercussions from the Sept. 11 terrorist attacks, which have contributed to a reduction in hotel property values.

2002 Transactions 2001 Transactions
January 7 12
February 2 12
March 1 8
Total 1st quarter 10 32
Source: HVS International

(Percentage change in total returns*)

Total Return
(As of June 10)
(Entire Year)
Retail 14.80% 30.42%
Shopping Centers 10.96% 29.89%
Regional Malls 18.54% 31.88%
Freestanding 17.51% 23.95%
Apartments 3.79% 8.67%
Office 6.60% 6.65%
Industrial 15.79% 7.42%
Lodging/Resorts 21.51% -8.07%
*Total return includes a stock's dividend income plus capital appreciation before taxes and commissions.
Source: NAREIT


This chart compares the dollar volume of commercial real estate sales closed in the first four months of 2002 with the same period in 2001.

Jan.-April 2001 Jan.-April 2002 % Change
Apartments $5.80 billion $5.10 billion -12%
Flex $1.60 billion $719.5 million -56%
Industrial $2.30 billion $1.50 billion -35%
Office — CBD $5.20 billion $2.90 billion -44%
Office — Suburban $6.90 billion $4.40 billion -36%
Retail $4.11 billion $4.07 billion -1%
Note: Real Capital tracks deals valued at $5 million and higher.
*The apartment category does not include seniors housing properties.
*Flex properties are those that feature both an office and industrial component.
*The industrial, office and retail categories include all of the product types within those sectors.
Source: Real Capital Analytics Inc.

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