SPECIAL REPORT: Torto Wheaton Sees Cap Rate Rise in 2006
By Eugene Gilligan Senior Editor
Monday, November 14 2005
Monday, November 14 2005
Published on AllBusiness.com
Cap rate compression on office, industrial, retail and multi-housing properties will come to an end next year, according to Torto Wheaton Research, a division of CB Richard Ellis, which presented its forecast for the 2006 commercial real estate market this morning in New York City.
"Change is afoot," said Craig Thomas, senior vice president of the firm. The firm projects that cap rates will increase, albeit at a modest pace, in all four of the commercial property sectors next year. Rising interest rates will contribute to that rise. The firm predicted that the yield on 10-year treasuries will increase to 5.16 percent in the second quarter of next year, up 100 basis from this year's second-quarter figure of 4.16. The yield will rise another 100 basis points, to 6.16 percent, in the second quarter of 2006. Cap rates will increase the most in multi-family assets, followed by industrial, office and retail.
The firm found that over the past three years, more than 100 percent of property appreciation has been due to cap rate compression. Going forward, appreciation will be determined more so by real estate fundamentals such as rent increases and decreasing vacancy. "We're not predicting a crash, not predicting a disaster," said Raymond Torto (pictured), principal & chief strategist for Torto Wheator.
In the last three years, cash-on-cash return from commercial real estate investment has yielded 11 percent, the firm said, but that return is likely to drop to the single digits. But Torto, who said he?s never seen such a variation, emphasized that returns are varying greatly in property types and locations across the U.S.
There may be opportunity for improving net operating income. The research report noted that from January 2000 to this past August, 3.5 million jobs were created. If 2 million jobs are created each year over the next five years, that means 14 million jobs will have been created in the decade. But then again, that's the smallest number since the 1950s, and a little more than half of the 26.6 million new jobs created in the 1990s. The firm predicted that rents in office properties should increase by 4.4 percent in 2006, but it?s well short of the 13.5 increase from 2000. Torto said that rents in multi-housing properties should grow by 3.1 percent, industrial by 2.7 percent and retail by 3.3 percent.
The firm, however, sees investment in real estate remaining healthy, with a solid amount of liquidity in the market, and prices for assets remaining high. "Investment managers are diversifying their portfolio through real estate investment," Torto said. "And they see that real estate investors can beat the market."
The explosion of consumer goods imported from China will also greatly influence the commercial real estate market going forward, especially in cities near ports, Torto said.
The flood of imported goods from China through the Port of Los Angeles-Long Beach has spurred warehouse development in the nearby California community of Riverside, Calif., Torto noted, but has also hastened development of office buildings and retail space to accommodate this increased activity. As importers look to diversify their ports of entry, because of security reasons and because of increasing dwell times for containers at the Port of L.A., Torto predicted that areas near the Port of Savannah in Georgia and the Port of Virginia (Hampton Roads) are likely to see a similar increase in development.
"Change is afoot," said Craig Thomas, senior vice president of the firm. The firm projects that cap rates will increase, albeit at a modest pace, in all four of the commercial property sectors next year. Rising interest rates will contribute to that rise. The firm predicted that the yield on 10-year treasuries will increase to 5.16 percent in the second quarter of next year, up 100 basis from this year's second-quarter figure of 4.16. The yield will rise another 100 basis points, to 6.16 percent, in the second quarter of 2006. Cap rates will increase the most in multi-family assets, followed by industrial, office and retail.
The firm found that over the past three years, more than 100 percent of property appreciation has been due to cap rate compression. Going forward, appreciation will be determined more so by real estate fundamentals such as rent increases and decreasing vacancy. "We're not predicting a crash, not predicting a disaster," said Raymond Torto (pictured), principal & chief strategist for Torto Wheator.
In the last three years, cash-on-cash return from commercial real estate investment has yielded 11 percent, the firm said, but that return is likely to drop to the single digits. But Torto, who said he?s never seen such a variation, emphasized that returns are varying greatly in property types and locations across the U.S.
There may be opportunity for improving net operating income. The research report noted that from January 2000 to this past August, 3.5 million jobs were created. If 2 million jobs are created each year over the next five years, that means 14 million jobs will have been created in the decade. But then again, that's the smallest number since the 1950s, and a little more than half of the 26.6 million new jobs created in the 1990s. The firm predicted that rents in office properties should increase by 4.4 percent in 2006, but it?s well short of the 13.5 increase from 2000. Torto said that rents in multi-housing properties should grow by 3.1 percent, industrial by 2.7 percent and retail by 3.3 percent.
The firm, however, sees investment in real estate remaining healthy, with a solid amount of liquidity in the market, and prices for assets remaining high. "Investment managers are diversifying their portfolio through real estate investment," Torto said. "And they see that real estate investors can beat the market."
The explosion of consumer goods imported from China will also greatly influence the commercial real estate market going forward, especially in cities near ports, Torto said.
The flood of imported goods from China through the Port of Los Angeles-Long Beach has spurred warehouse development in the nearby California community of Riverside, Calif., Torto noted, but has also hastened development of office buildings and retail space to accommodate this increased activity. As importers look to diversify their ports of entry, because of security reasons and because of increasing dwell times for containers at the Port of L.A., Torto predicted that areas near the Port of Savannah in Georgia and the Port of Virginia (Hampton Roads) are likely to see a similar increase in development.
