Jeffrey Havsy, Senior Vice President, Research

LaSalle Investment Management: "Industrial properties are relatively stable assets, and their cap rates don't vary widely. That's because it's easy to turn off the construction spigot, and warehouse supply never gets too far beyond demand. As the economy recovers, I expect industrial to do pretty well, with cap rates dropping slightly. By the end of 2003, I think industrial cap rates could slip below 9.5 percent. But they probably won't go below 9 percent."

Guy Jaquier, Chief Investment Officer, Vice Chairman

AMB Capital Partners, LLC: "There is some noise in median cap rates. Medians don't weigh differences between large and small markets. At AMB, we primarily track eight major industrial hubs: Atlanta, Chicago, Dallas, Los Angeles, Miami, Newark, San Francisco and Seattle. Prices in these markets tend to be higher than medians, while cap rates are lower. Historically, cap rates for institutional quality property in these markets hovered around 9 percent. During 2002, rates trended down and ended the year between 8.25 percent and 8.5 percent. I expect rates to remain in this range through the end of 2003. Rents, however, have been trending down. Although cap rates are down in historical terms, declining income has kept prices stable."

William Travers, Director, REIT Group

Fitch Ratings: "The relatively small movements of industrial cap rates during 2002 reflect the historical stability of this property type. Moving forward into 2003, we see some deterioration in property fundamentals in the category. As leases come up for renewals, rental rates are flat or modestly down and occupancies have eroded slightly—just slightly. Usually, weakening fundamentals lower property values. However, low interest rates and rising investor interest in real estate seem to be maintaining values today. We feel this trend will continue and keep cap rates steady throughout the year (between 9.5 percent and 10 percent)."

Philip Kibel, Vice President, Senior Credit Officer

Moody's Investors Service: "Industrial cap rates tend to be lagging indicators for both the economic and real estate cycles. Early in the second half of 2002, industrial cap rates moved to the high end of the range, because it seemed like vacancies had peaked. But vacancy rates rose in the third and fourth quarters and cap rates peaked around 10 percent. When the market realized that vacancy increases in the second half of the year would not be severe, cap rates fell back. For 2003, if interest rates do not go lower, cap rates will probably rise. I would make a guess that cap rates will rise maybe 50 basis points and end 2003 around 9.75 percent."

Multifamily Travails

In the multifamily category, Real Capital Analytics reports that median cap rates for garden apartments began 2002 at 8.6 percent, remained there through mid-year, and declined to about 8 percent by the end of the year. High-rise apartments in cities showed more volatility, shooting up from 8 percent to 8.5 percent at the beginning of 2002 and then plunging to 7 percent in September. By the end of the year, rates had moved back up to 8.5 percent. What caused this volatility and has it translated into opportunities for savvy investors?

Jeffrey Havsy, Senior Vice President, Research

LaSalle Investment Management: "Garden apartments have traditionally been a defensive investment during recessions. However, during this recession, apartments have not performed the way they have in the past. Low interest rates have enabled people to buy houses and move out of apartments. At the same time, real estate companies have been buying garden apartments. Buyer interest and lower fundamentals have combined to reduce yields. I expect garden apartment cap rates to begin to tick up by the end of 2003 to, say, 8.2 percent or 8.3 percent.

"In the high-rise category, companies have been anticipating demand coming from empty nesters returning to the city. I would have expected cap rates in that segment to move up in 2002, but not all the way to 8.5 percent. My expectation is that high-rise cap rates will be between 8 percent and 8.5 percent by the end of 2003."

Michael Mitro, Senior Vice President, Regional Manager

KeyBank Real Estate Capital: "My sense is that cap rates have probably hit bottom in both suburban and high-rise multifamily properties. I think the fundamentals of real estate will continue to weaken given the soft economy. With NOI getting weaker, cap rates can't go much lower. By the end of the year, cap rates will probably be close to where they are now: 8.2 percent for garden apartments and 8.4 percent for high-rise apartments."

Tim Welch, Executive Managing Director

Cushman & Wakefield: "During 2002, single-family home ownership rose from 67 percent to 69 percent of households. For every percentage point rise in home ownership, between 100,000 and 150,000 rental units go empty. That puts pressure on the multifamily category. Historically, garden apartments have traded in the range of 8 percent to 9 percent cap rates. Rates at the end of 2002 were at the low end of that range, and I don't see rates declining further. In the high-rise category, not many properties change hands so it is difficult to predict how high-rise cap rates will change."

Doug Gray, Executive Vice President

Post Properties, Inc.: "Cap rates in general in the garden apartment sector have been declining for 18 months, due to falling interest rates and the continued capital demand for multifamily properties. In 2003, companies buying multifamily properties have essentially been willing to accept a lower going-in yield than last year because they can borrow using a cheaper cost of capital and because they believe that demographics will be very positive for the next 10 years in multifamily.

"My crystal ball isn't perfect, but if put on the spot, my bet is that long-term interest rates will rise by the end of 2003. Increasing interest rates will leave cap rates slightly higher. If interest rates go up 50 basis points, cap rates for garden apartments might increase 25 basis points to 8.35 percent. In the high-rise sector, investors are generally willing to pay higher prices and accept a lower going-in yield. If tenants are willing to pay the rents asked by high-rise apartments, then cap rates in this sector might decline by 50 basis points by the end of the year to around 8 percent."

Lower Returns At The Office

According to Real Capital Analytics, 2002 cap rates for office properties in central business districts (CBDs) around the country moved from 9.5 percent to just below 10 percent during the year, and then fell to 8.5 percent in December. In the suburban markets, cap rates began 2002 around 10.4 percent, fell to 9.5 percent and hovered between 9.5 percent and 10 percent for the rest of the year. What factors impacted these changes and what does this pattern mean to investors interested in the CBD and suburban office markets in 2003?

Hans Nordby, Research Strategist

Property & Portfolio Research: "Last year, CBD office transactions tilted toward well-leased properties selling for slightly below average replacement costs of $207 per sq. ft. An 8.5 percent return (or cap rate) on a stabilized asset purchased below replacement costs sounds very comfortable to me. In 2003, if the stock and bond markets don't change, cap rates for well-leased CBD office properties will probably decline. As long as prices per square foot remain below replacement costs, I think cap rates of 7.5 percent would not be unreasonable by December 2003.

"In suburbia, leases are shorter, and there is more risk that tenants will move out. Rollover can be extremely expensive in terms of commissions, tenant improvements and incentives. That said, I look for suburban office properties to continue trading within their 2002 range and end 2003 around 9.5 percent."

(Editor's note: Please read Hans Nordby's take on the importance of spreads in valuing real estate investments in this issue's In Closing column.)

David Helfand, Chief Investment Officer

Equity Office Properties Trust: "CBD cap rates fell during 2002 in response to supply and demand. There was a tremendous demand for quality assets, particularly those with good credit tenants and long lease terms. This demand was a function of the broader investment market where other forms of investment were deemed risky compared to real estate. Suburban office cap rates fell during 2002 for pretty much the same reasons."

Tim Welch, Executive Managing Director

Cushman & Wakefield: "In March 2002, as CBD cap rates (which move in the opposite direction of price) were trending up, we began to see a flood of transactions. Sellers had been holding out for higher prices but finally gave up. At the same time, buyers began to appear with more money than we've seen in a long time. That drove cap rates down and values up for the rest of 2002. An added competitive element in the CBD market last year was offshore money.

"The suburban office category doesn't have that extra element of offshore money. So cap rates for suburban offices didn't fall as far as CBDs. This year, CBD office cap rates will creep back up to 9 percent, while suburban office rates probably won't move up more than 25 basis points. I expect these cap rates to end 2003 around 9.5 percent."

Michael Dorsch, Executive Vice President

iStar Financial, Inc.: "Cap rate increases in early 2002 resulted from deteriorating economic conditions following the Enron debacle and the high-tech collapse. As interest rates fell, returns for office properties with stable cash flows compared favorably to alternative investments, causing capital to flow into real estate, raise prices and drive down cap rates. Because real estate fundamentals, such as occupancy rates, were weakening, there was a flight to quality, causing CBD office cap rates to continue to decline through the end of 2002. In the suburbs, values stabilized around pronounced vacancy rates.

"For 2003, depending on the (impact of) war in Iraq and additional outbreaks of terrorism, we expect cap rates to stay relatively flat or increase slightly due to continued economic weakness, high vacancy rates, and interest rates that will probably begin to trend higher."

Will Retail Rates Stay Strong?

The retail sector is difficult to analyze due to the wide range of property types and regional demographic and economic factors. Median cap rates for strip center retail real estate stayed relatively stable during 2002, according to Real Capital Analytics. Rates stood at 9.5 percent at the beginning of the year, moved up to 10 percent by mid-year and then fell back to 9.5 percent. In the mall category, cap rates followed a similar pattern. Rates began 2002 around 9 percent, rose to 9.6 percent by mid-year, and then fell back to 9 percent by December. What do these trends suggest to companies and investors with an eye toward retail?

Hans Nordby, Research Strategist

Property & Portfolio Research: "Let me qualify my answer by saying that this category has a huge mix of properties: neighborhood centers, community centers and lifestyle centers. Some have grocery anchors and others don't. That said, I think overall cap rates may go down somewhat, but you will find significant differences between the sub-types of properties. Companies will pay-up for quality properties. Those properties without strong tenants, including anchor grocery stores, will not command strong prices. In the mall category, investors have to watch out for mall anchors. There are a lot of malls out there with sick anchors. Malls with solid anchors probably have sustainable cap rates."

Stephen E. Sterrett, Chief Financial Officer

Simon Property Group: "Cap rates on strip centers tightened in 2002 because consumer spending held up well during the recession and retail in general performed well. This year, I can see cap rates for strip centers tightening down to 9 percent by the end of the year. In the mall category, it's important to realize that there are only about 1,400 malls in the U.S., and too few transactions to make judgments from median cap rates.

"For example, the mid-year spike in mall cap rates resulted from two major transactions. Simon, Rouse and Westfield bought Rodamco's $5.9 billion portfolio. In that transaction, our cap rate was between 8.5 percent and 8.75 percent. In addition, General Growth bought JP Realty; the cap rate on this transaction may have been in the mid to high 9 percent range. Late in the year, two more major mall transactions occurred at much lower cap rates. For malls, 2002 cap rate movements followed these transactions.

"I'd like to qualify my prediction for mall cap rates at the end of 2003. These rates depend upon a small number of transactions, and the rates will also depend on the types of malls involved in transactions. That said, I would guess that malls will end the year about where they are now: Class-A malls will be around 8 percent and Class-B malls will be between 9 percent and 9.5 percent."

Jeffrey Havsy, Senior Vice President, Research

LaSalle Investment Management: "Retail strip centers today are split just like the office market. For centers with quality grocery anchors and no competition from Wal-Mart or Target in the grocery category, buyers will pay higher prices. These properties might see cap rates come down below 9.5 percent during 2003. In the mall category, investors will pay for dominance. But if a dominant fortress mall goes up for sale, most likely a REIT will acquire it before anyone else.

"There is a split in the mall market, too. Companies that own the third mall in a three-mall trading area will find themselves in trouble. With these qualifications in mind, I think mall cap rates will probably end 2003 somewhere around 9 percent."

Andrew Wright, Senior Consultant

Reis, Inc.: "The strip center sector will experience higher vacancy rates and lower rental rates during 2003, and this will lower NOI or the numerator in the cap rate calculation. We also anticipate that there will be some construction that will increase supply and put more downward pressure on NOI and raise cap rates—unless prices fall at the same time. I think cap rates will rise to around 10 percent by the end of this year. Regional malls were hit hard in the fourth quarter of 2002 and into 2003 as consumer confidence fell, and consumers scaled back purchases. I think this will cause the same kind of upward cap rate movement in malls as you see in strip centers, without the supply side risk (the threat of excess construction). I would expect mall cap rates to increase by 30 to 40 basis points and end the year around 9.5 percent."

Michael Fickes, based in Cockeysville, MD, is a regular contributor to Real Estate Portfolio.