One Frothy Sequel

The groundswell in sales and leasing transactions that bolstered the nation's top brokerages in 2005 shows no sign of weakening. In fact, many bullish observers now expect 2006 to shatter last year's record transaction volume. Just how lucrative was last year? The five highest-ranked brokerages on NREI's Top Brokerage Survey boosted the total dollar value of their sales and leasing transactions from $284.8 billion in 2004 to $351.3 billion in 2005.

“It's very possible that 2006 will replicate 2005 in terms of sales and leasing volume,” says Will Marks, managing director at San Francisco-based investment bank JMP Securities, citing heavy deal volume through the first five months of this year as one leading indicator.

Insatiable appetite

There's clearly no lack of investment capital on the prowl. Washington, D.C.-based law firm Goodwin Procter estimates that institutional investors will pour some $130 billion into the U.S. commercial real estate market this year, up from $90 billion last year and $64 billion in 2004. The firm has worked on several large real estate deals over the past 18 months, including the $4.8 billion privatization of listed REIT Trizec Properties in June.

“Fundamentals across virtually all property classes are very stable, and we don't expect that to suddenly change. It's also one of the broadest recoveries we've seen in some time since many markets are benefiting from rent and occupancy growth,” says Dr. Sam Chandan, chief economist at Manhatten-based data provider Reis Inc.

The office vacancy rate declined by 60 basis points to hit 14.1% in the first quarter, the largest quarterly decline in more than a decade. One driving factor has been strong economic growth. The GDP grew at an annual rate of 5.3% in the first quarter. As strong as that performance was, Chandan believes it's unsustainable. He expects the second-quarter GDP to register just 2.5% due to less employment growth and higher energy prices that are a drag on the economy.

One trend that bodes well for office fundamentals is that a limited amount of new supply is expected to hit the market. According to Reis, office completions during each of the next three years will register less than half of the roughly 126.2 million sq. ft. of new supply that was completed in 2001.

New supply will creep into the market gradually through 2010, but Chandan doubts that it will be enough to offset steady leasing demand. He also believes that the combination of lower vacancy and higher effective rents could prevent capitalization rates from barreling up in coming years.

“Growth this year could be more modest than last year, which could affect office absorption,” says Chandan, who still expects effective office rents to grow by 4.4% in 2006, the highest rent growth in five years.

View from the top

Both CB Richard Ellis and Jones Lang LaSalle posted stellar first quarters on the strength of heavy sales and leasing demand. Investors have taken notice, too, driving share prices in both companies up as much as 200% over the past 12 months. Shares in CBRE, for example, were trading around $22.45 on June 20, up sharply from a year ago when share prices were hovering in the low-teens.

For CBRE, the largest real estate services firm in the world, this rising tide resulted in the company recording $150.4 billion in investment sales and leasing transactions in 2005, up 18% over the previous year. By comparison, the No. 2 brokerage, Cushman & Wakefield, reported $69.3 billion in combined leasing deals and investment sales in 2005, up 32% over the previous year.

CBRE posted first-quarter revenues of $680.1 million, which represented a 26.3% increase over the $538.3 million it earned in the first quarter of 2005. About 37% of the firm's 2005 revenues were generated through investment sales.

While CBRE's reliance upon investment sales bodes well in a strong market, analyst Marks cautions that this exposure could hurt the company if sales volume begins to thin due to rising interest rates. Marks says that competitors such as Jones Lang LaSalle and Trammel Crow — both of which are publicly traded — draw a smaller percentage of their total revenues from investment sales.

For example, No. 6 brokerage Jones Lang LaSalle generated just 19% of its 2005 revenues from investment sales. It also drew the lion's share (or 43%) of its revenues from fee-based services such as property management and consulting. This suggests that Jones Lang LaSalle is less exposed than CBRE to a sudden decline in leasing and sales volume. But souring transaction volume doesn't appear to be likely until 2007 at the earliest.

“At mid-year last year we predicted that rising interest rates would slow down the sales market,” says Marks. “That didn't happen, and the second half was bigger than the first. It's hard to say that the balance of 2006 will be any different.”

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