Housing Bubble

Real Estate Capital Markets Report looks at 10 critical issues

May 29, 2003

NEW YORK, /PRNewswire/ -- While real estate prices are holding their own despite economic uncertainty, those who invest in real estate companies themselves should not be complacent, according to a report released today by the Real Estate Capital Markets Services practice of Deloitte & Touche LLP, one of the nation's leading professional services firms.

"We see some tough challenges for 2003 and beyond," said Dennis Yeskey, national managing director of the practice. "For one thing, most real estate companies have yet to put in place the organizational structures and processes needed to comply with new regulations for corporate governance and financial reporting, including new rules for consolidating real estate partnerships and recording the sale of a building. Even privately held companies have to care about independence, accuracy, and transparency, because these will be the new 'best practices' in the industry."

Changes in the regulatory and tax environments will result in rising costs, always a concern in real estate. But, these will not be the only pressures driving the need for aggressive cost-containment programs, according to the report, entitled "Real Estate Capital Markets: Top Ten Issues." Other operating cost variables -- including procurement, insurance, IT investment, M&A expenditures, and property maintenance -- will continue to impact profitability.

"Real estate firms are caught in a classic squeeze -- reduce operating expenses, while strengthening tenant relationships," said Yeskey. "The industry is lobbying for changes, particularly in the areas of depreciation schedules and capital gains, which would benefit the bottom line. But getting relief from legislation isn't the whole solution. More disciplined business practices and processes are a good idea."

According to the report, investors also need to consider how long real estate prices will remain aloft as the underlying economics of buildings deteriorate. Yeskey attributes this dichotomy to four trends -- interest rates at a record 40-year low; investors using real estate as a safe haven; the acquisition of property by pension funds and foreign investors; and the demand for "trophy" and "toy" properties. The effect of the four trends will increase competition for real estate and drive down the cap rates for real estate investments.

"Whether the recent drop in cap rates is temporary or more long-term will have important consequences," according to Yeskey. "For many investors, a temporary decline in values may not be a major concern. But, if real estate values fall back to earth, investors could see increased bankruptcies, workouts, and litigation involving joint venture partners and general partners. If book values decline, these investors may be forced to post losses in their real estate portfolios for the first time since the early 1990s."

Another strong message in the report targets corporate real estate owners. After years of cutting costs, corporations are taking a serious look at their real estate assets to find further restructuring efficiencies. Many corporations don't know the full extent of their real estate portfolio or the total occupancy costs of operating and maintaining that portfolio. Also, corporate real estate owners could be hit hard if municipalities raise property taxes to balance out other tax reductions.

"Real estate is often an untapped area for cost-reduction," said Yeskey. "First, a corporation should inventory all the real estate it owns or leases; from there, the company can use a variety of innovative strategies to reduce its real estate occupancy costs."

• Tax Developments. In an effort to stimulate the economy, Congress is considering a variety of proposals to cut taxes that could have significant impact on the attractiveness of real estate investments. At the local level, property tax increases prompted by budget deficits are leading firms to focus on innovative ways to minimize their property tax liability.
• Too Late to Sell, Too Early to Buy? Owners looking to sell are wondering whether they waited too long, while many prospective buyers are waiting in the hopes that deteriorating real estate fundamentals will lead to declines in sales prices. Whether office, retail, multi-family or travel & leisure, each product type triggers unique considerations.
• Continuing Lure of Global Investing. US investors continue to invest in overseas markets, although new investment may return in search of bargains if the US economy weakens. Foreign investors remain committed to the United States and are finding that they need to develop a local infrastructure if they are to be successful over the long term.

This is the sixth year that Deloitte & Touche has published its top ten industry issues report, which is derived from the firm's real estate tracking data and from interviews with industry leaders.

Source: Deloitte & Touche LLP