Real estate professionals say Washington remains strong, but federal cuts loom

November 27, 2011

Near the end of each year, Delta Associates quizzes senior executives who closely watch the real estate market in the Washington region. The canvassing covers 10 property types and includes questions about investments, development, market conditions and other factors in the coming year.

Following are highlights from this year’s responses:

Apartments lead the way

The Washington area remains a premier market compared with other metropolitan markets in the nation. According to respondents, Washington ranked 6.2 out of 10 in terms of its attractiveness for investments, the same score it received in 2010 and 2009. Scores ranged from 4.5 to 7.3, as each property type scored above the benchmark 5.0 investment worthiness line with the exception of Class B suburban offices. The significant shifts since last year include Class A high-rise apartments climbing five places to first, from sixth place one year ago.

Expect continued investment in Class A high-rise apartments, Class A suburban garden apartments and Class B suburban garden apartments, as these are the three most desirable real estate investment vehicles in the Washington area as the region heads into 2012. By many indices, the Washington area is the best-performing apartment market in the nation, as a transient work force has produced a large pool of Class A renters by choice and the limited number of new buidlings during 2011 has maintained the supply-demand balance.

Capitalization rates down 30 points

The average capitalization rate — or the ratio between a building’s operating income and its value — is 6.66 percent for all product types as the end of 2011 nears, reflecting a 30 point decline for the year. The decline results from low interest rates and increased demand for quality Washington area real estate assets. We believe such rates will hold at this level in the near-term, as demand for quality assets in the Washington area remains heightened due to projected job growth.

Neighborhood shopping centers showed the largest capitalization rate decline during 2011, at 70 basis points. But well-located, Class A, neighborhood shopping centers with dominant grocery anchors fared well during the recent downturn, as these centers were able to keep and lure quality tenants from Class B centers.

Demand for quality assets should rise as equity-laden investors take advantage of this market. Given the tepid nature of the economy, any further decline in capitalization rates during 2012 is likely to be modest. Therefore, most price increases will likely be earned from improved property performance.

The regional economy stabilizes

The threat of federal austerity measures has reduced expectations some but has not significantly diluted investor interest in Washington real estate assets.

Sixty percent of respondents believe that business conditions during 2011 were about the same as conditions experienced during 2010, while 28 percent of respondents believe conditions during 2011 were better than conditions during 2010. Just more than half, 52 percent, believe conditions in 2012 will mirror business conditions experienced during 2011.

Forty percent of respondents focusing on the office sector believe conditions will be better in 2012, with the same number stating conditions will remain the same as in 2011. Thirty-six percent of respondents focusing on the apartment sector believe conditions will be better in 2012, compared to 55 percent stating conditions will remain the same as in 2011.

Elizabeth Norton is vice president at Delta Associates. Staff at Delta Associates contributed to this article. For more information, please visit www.deltaassociates.com.

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