Correction to Commercial Real Estate Sector Likely in 2006

Investors Should Look for Opportunities in Niche Markets

DALLAS - The experts have spoken, and a real estate market correction is widely anticipated for 2006. Despite a continuous flow of capital into commercial real estate in late 2005, many of the biggest investors have sold assets. Amid so much uncertainty, what should real estate investors expect in the coming year and how can you protect your portfolio?

Real estate advisor Dean Macfarlan, who has been successfully tracking real estate trends for more than two decades, offers insight to the current market state.

"We're seeing the highest prices paid for core assets that we've seen in 20 years, and most people see a correction coming," Macfarlan said. "But, even a 20 percent correction won't produce a meltdown, just a flat year. Opportunities will exist for investors in 2006 if they know where to look, have knowledgeable counsel and allow enough time to let their investments mature.

Macfarlan offers the following three tips for investors seeking to balance and safeguard their portfolios in 2006 with investments that yield, healthy, long-term returns.

Move Away from the Core
Investors need to be much savvier about where they're putting their money in 2006. Macfarlan advises investors to move away from the kind of asset that has been considered "core" commercial real estate -- trophy properties in top -- tier markets.

Too much capital has been chasing too few good deals for too long, with hedge funds, private-equity groups, and rich investors all bidding up the same properties. Yields on some high-quality properties are now 5-6 percent. "Investors putting money into commercial real estate with this kind of return would be better off in bonds," he said.

Less obvious niches will be the profitable places to invest. High-rise office towers, retail and multi-family properties are mostly overpriced. Even warehouses and industrial buildings in primary markets are no longer the sure- thing they were a year or two ago.

Macfarlan identified three strategies for real estate investment in 2006 that he believes will produce quality returns:

• Investment in recovering niches such as luxury hospitality
• Investment in select secondary and tertiary markets
• Investment in new emerging sectors like healthcare real estate

"Private Residence Clubs emerged as a marquee investment niche in 2005," he said. "We made investments in properties in Scottsdale, Tuscany, Exuma and all are performing ahead of pro-forma. And it has only just begun." Macfarlan said Private Residence Clubs have just a 2-3 percent market penetration so they offer tremendous room to grow, particularly among Baby Boomers with cash to spend on luxury. "We'll do more investing in PRCs in 2006," he said.

Macfarlan also turned to less coveted markets and often overlooked properties. Macfarlan made off-market investments in Atlanta, St. Louis, Tulsa, Oklahoma, as well as investing in properties owned or leased by solid companies emerging from bankruptcy. These deals required a greater degree of due diligence, but the work paid off with higher returns than similar properties would have in top-tier markets.

And, Macfarlan made the first of a series of investments in healthcare properties in 2005, acquiring a surgery center and medical office building. Future investments could be in elderly housing, outpatient surgery centers or hospitals, where barriers to investment are high and demand is booming.

"Build In" Building Costs
Although many people are only just beginning to take notice, the catalyst for a downturn in real estate next year could be the steep rise in the cost of building materials. Construction costs have skyrocketed 30 percent in the past nine months as the housing boom created shortages of labor and materials like lumber and concrete. The rebuilding of 632,000 homes in New Orleans pushed lumber prices up 50% in some areas just three weeks following hurricane Katrina. Additionally, the high price of oil, needed to produce everything from roofing to PVC piping, has contributed to the price increase.

The impact of these price increases will show up first in speculative hot spots like Miami and Las Vegas, where developers are pre-selling properties at what seems like a high profit. But they won't be able to build them for the prices they're now getting, and many developers will be stuck with the bill. The proverbial "bubble" could burst here first and be felt across the nation.

Keep Your Eyes on the Horizon
Investors should be prepared to weather a correction by leaving their money invested long enough to realize healthy returns. "With a longer horizon, people will weather the storm and make money," he said. "If you are investing for the short term, 2-3 years, 2006 may be a bad year to invest."

Macfarlan said commercial real estate is now recognized as a fourth asset class, attracting capital comparable to stocks and bonds. And, while returns on commercial real estate in the short term may be unimpressive, the same will be true for stocks and bonds which experts predict will yield a modest 6-7 percent return over the next 5-7 years.

"A market correction doesn't mean that there won't be opportunities in 2006," he said. "But investors will need better guidance in finding niche investments, anticipating rising costs and keeping realistic investment horizons."

Source: Macfarlan Real Estate Investment Management Press Release
Macfarlan Real Estate Investment Management is a national real estate investment management firm which has purchased over $800 million in real estate investments on behalf of pension funds, Wall Street investment funds, family offices and individual investors. The company's unique offerings include income, value-added and opportunistic investments. Macfarlan provides investment programs with superior returns through targeted strategy funds, single asset partnerships, and tenant-in-common ownership structures. The firm acquires and develops office, industrial, healthcare, and luxury hospitality properties located across the United States and abroad. For more information please visit: http://www.macfarlan.com.

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