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Economic Environment

The best news about the economy during first quarter 2011 was that the unemployment rate ended the quarter at 8.8 percent, down from 9.4 percent at the end of fourth quarter 2010, according to the Bureau of Labor Statistics (BLS). Payroll began to increase by slightly better numbers. However, first-time unemployment claims began inching up again in April 2011, jumping to more than 400,000 per week for several weeks in a row.

Real gross domestic product (GDP) growth increased at an annual rate of only 1.8 percent in first quarter 2011, according to the advance estimate released by the Commerce Department. This was a deceleration from the 3.1-percent growth in fourth quarter 2010, with the slowing growth largely due to reduced personal consumption expenditures, a sharp upturn in imports, and the decrease in government spending.

Standard & Poor’s (S&P) lowered its outlook for U.S. sovereign debt from “stable” to “negative” during first quarter 2011. In addition, the federal debt exceeded $14.3 trillion in May, and Congress will need to raise the debt ceiling again within the next couple months or the nation will risk defaulting on our obligations.

According to the BLS, the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in March 2011, with gasoline and food prices accounting for almost three-fourths of the increase. As such, consumers are pulling back, and while U.S. retail sales rose 0.4 percent in March 2011, this was down from the 1.1-percent increase in February, according to the Commerce Department.

What Does This Mean for Commercial Real Estate?

Despite the uncertainty in the economy and investment environment, commercial real estate continues to be a reasonable investment alternative for institutional investors. However, demand for investment property in secondary or tertiary markets is generally weak in comparison to that of the top-tier markets. We are starting to see slight improvement in leasing activity in some areas, particularly among technology firms.

Lending standards started to ease in first quarter 2011, according to results of the Federal Reserve’s quarterly Senior Loan Office Opinion Survey, but demand remained weak and growth remains tentative. In addition, problem banks remain at a record high, with 884 banks, or nearly 12 percent of all U.S. banks, at risk of failure at the end of 2010, according to the Federal Deposit Insurance Corporation (FDIC). The total number of failed banks in first quarter 2011 was 26, and another 13 banks failed in April, reported Trepp, LLC.

According to the Federal Reserve, banks have already taken $80 billion in commercial real estate losses (about half of what they are expected to take as a result of the recession). But there is still much distress, and the delinquency rate on commercial mortgage-backed securities (CMBS) increased to a record 9.34 percent in fourth quarter 2010 (compared to less than 1 percent in 2007). In contrast, the volume of new CMBS issuance is expected to be about $45 billion in 2011, well above 2010 issuance of $10.9 billion, but far below the $228 billion in 2007.

Transaction Analysis

On a 12-month trailing basis, total volume increased approximately 20 percent in all property types during first quarter 2011, according to Real Estate Research Corporation (RERC). In contrast, the 12-month trailing size-weighted average price decreased slightly in all property types. On a quarter-to-quarter basis, total volume decreased from the previous quarter in all property types during first quarter 2011, while the size-weighted average price declined.

RERC’s 12-month trailing weighted-average capitalization rate for the industrial and retail sectors declined during first quarter 2011, while the cap rate for the apartment sector remained mostly unchanged. In comparison, the 12-month trailing weighted-average capitalization rate for the office sector increased from the previous quarter.

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• According to RERC’s investment survey results, distressed and foreclosed property sales dominated office transactions in first quarter 2011. One of the commonly reported strategies was to buy cheap, hold, and sell the property at a higher price when the economy improves and office demand increases.

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