While there is broad demand for property across all investor types, only the REITs, both public and private, and to a lesser extent, foreign investors have been successful in growing their portfolios this year. A common factor among these investors is that they primarily target core, assets with stable cash flows, which has caused robust bidding and some surprisingly low cap rates on recent transactions. Acquisitions from all three of these sectors are gaining momentum which will continue to exert upward pressure on prices of lower risk, higher quality assets.

At the other end of the spectrum, distressed properties are being reclaimed by lenders at a rapid pace but relatively few are being re-sold to investors. Lenders have acquired approximately $10 billion of significant commercial property so far in 2010 - via foreclosure or negotiated settlement - and have disposed of just $2.6 billion of REO property. Thus the property portfolios of lenders have increased far more than any of the traditional investor groups. The REO inventory currently held by lenders resulting from this cycle now exceeds $28 billion, all of which will have to be sold in the future, but the timing is still uncertain.

Foreclosures and other transfers of property to the lender are not arms-length sales and therefore are not included in volume statistics, but these transactions have been incorporated into this analysis in order to account for the changes in CRE portfolios among all the current participants in the market. It underscores that although lenders have been a relatively minor factor as sellers, the inventory of REO is growing quite large and going forward this will be a sector to watch closely.

There is a large amount of capital that is eager to acquire these assets from the lenders, at appropriately discounted prices, but lenders do not have pressure to sell their REO immediately, and most are content to wait for conditions to improve further before selling. Consequently, private investors and opportunistic funds have not been able to deploy much capital and these sectors have actually seen their portfolio holdings decrease this year. Not all of these dispositions were made voluntarily; nearly half of assets sold by equity funds in 2010 and about a quarter of the dispositions by the private sector were either transfers back to the lender or lender-forced sales to third parties.

Besides the massive transfers of property back to lenders, the most significant change in capital flows has been in the public REIT sector. They have become net buyers of property again after four straight years of selling where net dispositions, including privatizations, totaled over $130 billion. Across every property type, REITs have become net buyers in 2010 except in the apartment sector where acquisitions and disposition to date are equal, but they are expected to move into positive territory soon. In our recent analysis on “Top Buyers and Top Sellers” public REITs dominated the list taking six out of 10 spots. Healthcare REIT was the second most active buyer.

Compared to the peak of the market in 2006 and 2007, the shifts in capital flows are dramatic. The largest buyers then - institutions and equity funds – are now net sellers. Institutional investors are net sellers now across all property types, but there is no longer severe pressure from the denominator effect or from redemption queues and reports of new allocations are trickling in. Trouble with the heritage investments made by equity funds is weighing heavy on that sector since nearly half of the decline in their portfolios this year result from foreclosures. However, a new vintage of equity funds have raised significant capital for opportunistic acquisitions and one of the uncertainties in the market is how patient that capital will be if distressed opportunities remain scarce. Continuing trends in the capital flows to property include the steady stream of capital from the non-traded, or private REITs. They are well on track to meet or exceed their highest prior levels of activity, set in 2006 – and are the only group whose acquisition activity even approaches the levels spent that year. Now, though, set against what will surely be a much smaller overall market, this investor group is gaining clout in the marketplace. (See past article).

Another relatively stable trend in the capital flows is the interest in US property from foreign investors. Although they were slight net sellers in 2009, largely due to Australian dispositions, they have returned to a buying mode in 2010. Within the cross-border sector, however, there are significant changes in the sources of the capital with more capital derived from Asia and other investors, particularly Australians and Irish, are now absent. (See past article).

Data subject to future revision; based on properties & portfolios $5 mil and greater.
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