Commercial real estate race--rates vs rent

By Ilaina Jonas

NEW YORK (Reuters) - In commercial real estate investing, the race is on between rents and interest rates, some of the top names in the real estate industry said at the Reuters Real Estate Summit in New York.

It's part of the reason behind the latest trend of private buyers, such as Blackstone, who are buying publicly traded real estate companies and taking them private, said Richard Kincaid, chief executive of Equity Office Properties Trust EOP.N. His firm is the largest owner of U.S. office property outside the federal government.

"It's a bet on rent," Kincaid said on earlier this week. "What people are betting is that basically total return or cap rates stay relatively low, or even if they go up a little bit, rents go up more. It's not inconceivable. It's just a question of how much risk you want to take."

An initial cap rate is equivalent to a first-year interest rate a buyer is willing to accept on his property investment. Cap rates and prices move in opposite directions, so if cap rates rise, then prices generally fall.

However, rent increases that generate cash flow can offset the effect of rising cap rates.

"The question is of course is will the cash flow growth -- rental and occupancy -- outrun cap rate reversion," said Michael Pralle, chief executive of GE Real Estate, the real estate arm of General Electric Co.(GE.N: Quote, Profile, Research, Stock Buzz)

With long-term interest rates rising slowly, commercial real estate investors said cap rates may start to rise. Rent growth becomes an ever increasing factor in determining property price.

Office properties might be best-positioned to ride out any increases in cap rates.

"There's probably going to be some modest uptick in cap rates for office, but we feel the cash flows will outrun that," Pralle said. "Whereas in retail, we don't think that's going to be the case. We think that's going to be the hardest."

The supply of office space versus demand in desired areas will probably spark rent spikes, real estate executives say.

Pralle added another real estate segment, warehouses and distribution centers, is also attractive globally.

"Industrial is always a pretty good class. It tends to be pretty stable," Pralle said.

Apartment complex owners also could thrive even in a higher cap-rate environment.

David Neithercut, chief executive of Equity Residential EQR.N, one of the largest U.S. apartment landlords, remains very optimistic about the apartment market.

"Cap rates may be moving up in some areas; but the top lines are also moving up a great deal, so values are not going down," he said. "Values are at least holding steady and going up modestly. Not at the same rate we saw them go up in 2005."  Continued...