Real estate investments still seen as a haven

After almost 11 months of inaction on interest rates, the Federal Reserve scraped the rust off its ax two weeks ago and chopped the discount rate by half a percentage point.

The aggressive rate cut took many observers by surprise. Commercial mortgage rates had actually risen during the past month by about two-tenths of a percentage point and are now in the range of 4.88 percent to 5.88 percent for fiveand 10-year fixed-rate mortgages, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

The general economic and political currents facing the nation - a stumbling economy and a possible showdown with Iraq - would seem to undermine confidence in real estate at a time when an enormous amount of commercial mortgage-backed securities are scheduled to come to market. (These securities, called CMBS, are real estate loans bundled together and sold as bonds.)

Normally, an overabundant supply of CMBS would tend to increase the pricing on commercial real estate loans, but this time the effect is slightly different. The various crosscurrents are making investors run to real estate as a "defensive play" or a haven.

This "sector shift" has occurred for the past six months, and the end does not appear to be in sight. Despite continued deterioration in real estate fundamentals, a significant amount of capital is still chasing real estate debt and equity transactions.

Real estate fundamentals are loosely defined as a balance of supply and demand for apartments and retail, office and industrial space. The deterioration of fundamentals means that employment growth has halted and jobless rates have grown. This is a bad sign for office space and apartments because companies aren't expanding and fewer people have jobs. In addition, consumer confidence is waning, which is bad for the retail sector.

Lower interest rates are certainly playing into the relative frenzy being experienced on debt and investment sales sides of the business, but real estate fundamentals are driven by employment growth and the resultant leasing. According to a national publication issued by Torto Wheaton Research, excess space in all types of real estate is likely to persist for at least 12 more months.

Richmond's industrial- and office-market specialists would not argue with that estimate. According to a third-quarter market review published by Insignia Thalhimer, Richmond's office market has functionally vacant space that amounts to all the growth (or absorption) that has occurred during the past five years.

Nonetheless, Jason Hetherington, an industrial-property specialist at Grubb & Ellis/Harrison & Bates, was a bit more optimistic. "At least tenants are out looking again; for the past six months I couldn't get anybody but my dog to ride in my car," he said.

The Richmond apartment and retail markets appear to have more vitality. The Insignia Thalhimer report says leasing at two new malls, Short Pump Town Center and Stony Point Fashion Park, will result in a raft of new retailers coming to the market. About 3 million square feet of new retail space is under construction. Further, about 500,000 square feet of vacant "big-box" space from faltering retailers was leased during the first three quarters of the year.

The apartment market also has been active, with several large projects trading this year and some new construction, particularly downtown and in the far West End.

Andrew Little is an investment banker with John B. Levy & Co.