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CBRE Earnings a Sign of Office Rebound

Signs of an office leasing uptick are increasing. In April came the news that first quarter average asking rents had risen on a national basis for the first time since 2002. And vacancy rates continued to fall—to about 15.4% in major markets. More recently, CB Richard Ellis, real estate’s largest brokerage concern, reported a 22% jump in revenue for its first quarter. The Los Angeles-based firm reported net income of $14.6 million, or 19 cents a share, for the first quarter of 2005 compared with a $16.6 million loss, or 26 cents a share, in the first quarter 2004. First quarter operating income was $36.6 million versus a $9.2 million loss in the first quarter 2004.

CBRE’s percentage of leasing revenues overshadowed its strong investment sales business during the first quarter. A full 38% of CBRE’s revenues — or $205.5 million --were generated through leasing transactions during the first quarter, a 7% increase over the $138.7 million in leasing transactions recorded during the same period a year ago.

Investment sales accounted for 34% of the firm’s first-quarter revenues and continued at a brisk pace. Revenues from investment sales rose 31% in the 12-month period ending March 31. The firm posted investment sales-related revenues of $182.1 during the first quarter this year, vs. $138.7 million in the first quarter of 2004. Several large deals, including a $440 million industrial property sale in Atlanta in which CBRE represented the seller, helped bring the firm’s investment sales earnings up.

“The U.S. leasing market continues to recover with surplus office space being absorbed in many major metropolitan areas. Notably, office rents rose modestly on a national basis, and landlords have curbed their concessions in the face of reduced availability of space,” says Brett White, president of CB Richard Ellis.

What are the market drivers behind this upturn? Legal and financial services firms were responsible for much of the leasing activity in markets such as New York and Washington, D.C. Meanwhile, CBRE reports that sublease space continues to be leased or re-absorbed by existing tenants.

The European investment market also helped. According to White, the firm’s EMEA (Europe Middle East Africa) business posted a 27.9% revenue increase. The EMEA component—which is concentrated in Europe—brought in revenues of $79.8 million in the first quarter 2004. By comparison, these markets generated $102.1 million during the first quarter.

“Clearly, real estate trends are moving in the right direction — principally investment activity, but also in terms of leasing activity — which is expected to continue driving CBRE’s growth over the remainder of the year,” wrote Bear Stearns’ real estate analyst Ross Smotrich in a May 5 note.

“The U.S. investment business remains robust due to capital continuing to flood the real estate market, and leasing volume is picking up. Global investment trends also appear to be positive, as investors flock to those markets in search of higher risk-adjusted yields,” adds Smotrich.

Bear Stearns’ expects CBRE to outperform the market over the next 12 months. It helps that the April jobs report was better than expected. Non-farm payrolls grew by 274,000 last month, making it the fifth largest monthly gain in five years. Wall Street had expected a much more modest increase of 174,000 jobs.

Another piece of good news: recent job gains have not been concentrated in any one sector, which suggests that the momentum in the labor market is widespread. The leisure and hospitality sectors posted the largest gain in April, creating 58,000 new jobs. Health care also added 28,000 new jobs, according to the Department of Labor. Both of these sectors typically require office space for their new hires.

Still, the macroeconomic outlook is mixed. Many economists worry that rising energy costs and higher interest rates will slow growth later this year. Over the past 12 months, the Federal Reserve has raised short-term interest rates eight times. The Federal Funds rate—the interest rate on overnight loans between banks--now stands at 3%. But long term rates remain low, which has helped draw more capital into the sector.

Given this mixed economic picture, some investors are skeptical. Kenneth Rosen, chairman of the Fisher Center for Real Estate at University of California at Berkeley and chairman of Rosen Real Estate Securities, believes that too much of a good thing isn’t healthy.

“Too much capital will literally kill the goose that lays the golden egg. It will also lead to a wave of new construction,” he says. Rosen doesn’t believe that the low cap rates and bullish feelings just aren’t sustainable. He projects that the REIT market will post as much as a 20% decline in value over the next few years. Unlike other investors, Rosen has acted on those concerns.

“We’re shorting the REIT sector, and we have been for the past few months.”

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