This Could Be a Good Year for Commercial Real Estate

Commercial real estate
Commercial real estate

Several billion-dollar deals made this week have put commercial real estate investors in an optimistic frame of mind: Perhaps real estate investments can do far better than expected in 2011. Improving economic conditions and a limited supply, analysts say, appear to have lifted the industry past the worst of its downtrend during the Great Recession, while positioning it to make a sustained comeback in 2011.

"If you recall, 18 to 24 months ago this market was the next shoe to drop [in the financial crisis]," says Michael Torres, CEO of Adelante Capital. "We have averted the crisis, and there is money to be made."

Adelante Capital invests roughly $2.5 billion in hard real estate assets, real estate investment trusts and real estate-rich companies such as Starwood and Marriott -- companies that hold large amounts of commercial properties but are not REITs (real estate investment trusts). Torres says the easy money in commercial real estate has already been made -- because the industry saw gains of more than 20% over each of the last two years as it recovered from its 2008 lows.

The FTSE NAREIT (National Association of Real Estate Investment Trusts) U.S. Real Estate Index reported returns of 27.45% in 2009 and 27.58% in 2010. And the consensus on Wall Street is commercial real estate should grow in the 5% to 15% range this year. However, the Blackstone Group's $9.4 billion deal to purchase several U.S. shopping centers and Ventas's $5.7 billion buyout of a health care REIT indicate a level of interest in commercial deals that could see those projections improve.

Supply, Demand, Concessions and Investments

According to Torres, the commercial real estate market will benefit from two factors in 2011. First, minimal demand for new space has cut down on new construction, giving current structures an opportunity to regain some of the value they may have lost during the 2008 bust. Greater optimism brought on by the current economic recovery has also helped increase appraisal values. "Having no new supply has allowed the economic recovery to get a footing into the market place," says Torres.

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And second, those better economic conditions are beginning to favor property owners in a number of ways. As companies ramp up for growth, the some real estate should increase in value significantly -- depending on the location and type of space available. Certain property types with specific amenities will attract higher rents -- and some cities will see the value of their commercial real estate jump, due to its proximity to valued resources.

Torres notes the concessions that owners previously had to make to attract or retain tenants are decreasing, "and owners are stepping up their expectations on rent."

Higher rents mean higher revenues for commercial properties, which make them good investments for the future. However, investing in the actual properties isn't always practical, so Torres suggests that retail investors look at the iShares Dow Jones Real Estate Index ETF (IYR), the $3 billion passive exchange traded fund that tracks commercial real estate. The Vanguard REIT Index ETF (VNQ) is also an option for those who want some broad exposure to commercial real estate.

Torres says a basket of five to seven real estate investment trusts, targeted to different asset types and management styles, should provide enough diversification to minimize portfolio risk.

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