A Time To Rebuild

Real estate will rise slowly from the ashes this year. Housing is emerging already, and there are stirrings of life in commercial properties. But a soaring recovery isn't yet in sight for the industry, which has been transformed by five tough years. A better economy notwithstanding, property values will be ruled by supply and demand in 1994, not by '80s-style speculative excesses.

Housing provided much of the good news for real estate last year, as low interest rates enticed many first-time buyers. Sales of existing single-family homes totaled 3.7 million, up 5%-plus. The National Association of Realtors (NAR) predicts that sales of existing homes will grow 10% this year, and that prices will rise to a median $110,900 from $106,000 in October, 1993. Single-family home starts, after rising 6% in 1993, to about 1.2 million, should jump 10% in 1994, to 1.37 million, predicts the National Association of Home Builders (NAHB).

The possible bugaboo in the housing markets is interest rates. But the general consensus is that rates won't rise dramatically from the current 7.29% on a 30-year fixed mortgage loan. "Even if rates go up a couple of points, they're still at the lowest levels of the past couple of decades," says J. Larry Sorsby, senior vice-president for finance at $600 million homebuilder Hovnanian Enterprises Inc. in Red Bank, N.J. He argues, in fact, that an uptrend could unleash home purchases by fence-sitters who are waiting for rates to bottom. Sorsby doesn't expect residential activity to drop off until the rate on 30-year mortgages approaches 9% to 10%.

OFFICE PARTY. The outlook for multifamily housing is also brightening. Granted, vacancy rates still hover around 10%, even though there hasn't been much new supply in years. But the 77% decline in multifamily housing starts since 1985 appears to have ended. A provision in last year's federal budget act making permanent a tax credit for building and renovating low-income housing "is responsible for all of the increase we see in 1994," says Stanley Duobinis, director of forecasting for the NAHB. Duobinis expects multifamily starts to reach an annual rate of some 213,000 by yearend, up 35% from last year.

The fortunes of many commercial business districts are also stabilizing. The national vacancy rate for office properties inched down 0.4%, to 16.6%, in 1993's third quarter, real estate brokerage Grubb & Ellis Co. in San Francisco reports. That's well below the 1990s high of 18.9%, though still plenty above the 1980s low of 9%. Rates fell in 27 of the cities tracked by Grubb & Ellis, including Miami and Denver, and rose in seven, including Detroit and Houston. Rents, however, are flat, in part because of corporate downsizing.

"HOTELING." That also helps explain why suburban office markets may fare better than central city business districts in 1994. In Dallas, for example, vacancy rates in the suburbs inched down to 24.2% in 1993's third quarter, but downtown they rose five points, to 31.5%. Telecommuting is a factor, as are practices such as "hoteling," where a number of employees, such as traveling salespeople, use the same office at different times. "Technological change is reducing the need to warehouse people in big buildings," notes John Tuccillo, economist for the NAR. Times are still tough in the retail sector, where only top-quality, well-located malls are thriving. Their next worry: interactive home shopping.

One of the biggest changes in the real estate market is the availability of capital after a long dry spell. Money is beginning to flow both to developers who take their properties public via a real estate investment trust (REIT), a sort of mutual fund of properties, and to large homebuilders looking for credit--not necessarily from traditional lenders. Hovnanian took advantage of low interest rates in 1993 to issue $200 million of subordinated debt in 10- and 12-year maturities. "We've shifted our dependence more toward long-term capital and use bank debt more for short-term working capital needs," says Sorsby.

Much of the new capital reflects interest on Wall Street in the fees generated by turning real estate into a more liquid investment with an active secondary market. The sale of securities crafted out of pools of commercial mortgages is one way to do that. A more popular method is to issue stock in a REIT, which holds actual properties. About $10 billion worth of REIT initial public offerings hit the market in 1993. While still a fraction of the real estate market, REITs grew from a market capitalization of $8.7 billion in 1990 to $30 billion in 1993, though a glut of new issues may cool off the market in 1994.

In short, the years of free-fall in real estate values are over. And bit by bit, the foundation is being laid for a solid rebound.