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Dynamic Duo? Apartments, Industrial Gain Favored Status

“Bleak” may be one of the most common descriptors for the national commercial real estate market outlook in 2009. But according to new research, apartment and industrial properties are expected to rebound sooner than other sectors.

When will that recovery occur? Not until later this year or the beginning of 2010 at the earliest.

“In general, apartment and industrial markets should be less negatively impacted by market fundamentals in the near term, with strong fundamentals in the longer term making them less risky investments,” says Alan Billingsley, head of research in the Americas for RREEF.

RREEF is the alternative investment management division of Deutsche Asset Management, a member of the Deutsche Bank Group, which has more than $67 billion in assets under management.

While nearly every apartment market is expected to post declines in rents and occupancies over the next two years due to rising unemployment, RREEF’s research indicates that properties located in supply constrained markets near employment centers will hold up the best of all property sectors.

In the short term, apartments will compete with for-rent housing in many markets, with the national vacancy rate expected to peak at 7.4% in 2009, up from 6.6% in 2008, according to New York-based researcher Reis.

But due to favorable demographic trends, coupled with recovery in most employment markets over the next three to five years, apartments should perform better than office, industrial and retail.

In fact, RREEF Research projects a remarkably strong recovery for apartments between 2011 and 2015, owing much to a slowed new development pipeline. Deliveries of new apartment units are forecast to drop to 1993-94 levels of 40,000 annual units by mid-2010.

Other investment managers are singing the same apartment tune. “Long term, pension funds will continue to like apartments,” says Chris MacDonald, managing director and co-founder of Newport Beach, Calif.-based Buchanan Street Partners.

The national real estate investment management firm has $2.5 billion in assets under management for institutional investors. (Buchanan Street is affiliated with TCW, a large investment management company with $100 billion in assets under management.)

“Over time, apartments have provided the most stable income and appreciation for investors’ portfolios,” says MacDonald. “They have proven to increase returns and stability of an overall real estate portfolio, and the demographics speak well for apartments.”

Investors should also keep their eyes on industrial investments, particularly in core markets, according to RREEF. The downturn for industrial properties is expected to be less severe than other sectors due to a general lack of overbuilding and less severe cutbacks in tenant demand for space. Industrial should also bounce back to health more quickly than office and retail.

When it comes to the short haul, however, the numbers aren’t so positive. In particular, RREEF expects the U.S. industrial vacancy rate to rise from 11.3% in 2008 to 12.8% in 2009 and peak at 12.9% in 2010. Net absorption is expected to reach negative 143.6 million sq. ft. in 2009, which is about equal to the negative absorption recorded in 2001.

By 2010, the industrial sector is expected to post modest growth in new demand, with about 16 million sq. ft. of positive net absorption. The development pipeline will shrink to record low levels over the next three years, averaging less than 50 million sq. ft. per year.

At the other end of the spectrum, RREEF is warning investors to be more circumspect of office and retail properties. According to the Bureau of Labor Statistics, nearly 1.9 million jobs were lost nationwide in the first quarter of 2009, and with unemployment still on the rise companies continue to cut back on their office space requirements.

At the same time, consumer spending has dried up and retail vacancies will likely increase to 10.5% in 2009, according to Reis, as retailers halt expansion and many look to bankruptcy as an exit strategy.

Retail properties have already seen a significant decline in value over the past 12 months. RREEF estimates that values have fallen by 30% or more since their 2007 peak.

The National Council of Real Estate Investment Fiduciaries’ property index, which is typically slow to recognize market changes, provided a total return of negative 6.5% for all of 2008. For 2009, RREEF is forecasting a total return ranging between negative 9% and negative 11%.

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