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2007-12-21 12:15:00

Commercial Real Estate Fundamentals Sound, Investment Slowing

Lawrence Yun, chief economist, National Assn. of REALTORSThe fundamentals in commercial real estate remain healthy with only slight increases in vacancy rates expected for the office and industrial sectors during 2008, although credit restrictions have recently slowed overall investment activity, according to the latest COMMERCIAL REAL ESTATE OUTLOOK of the National Assn. of REALTORS®.

NAR Chief Economist Lawrence Yun said commercial fundamentals are essentially sound.  “Although vacancy rates remain relatively low for all sectors, they are expected to rise slightly in the office and industrial markets during the coming year because much of the space being absorbed is in high-quality buildings or is built-to-suit,” he said.  “As a result, there is a fair amount of older space on the market, particularly in the industrial sector where obsolescence is a factor, although industrial rents are showing healthy gains.  Vacancy rates in the retail and multi-family sectors are projected to tighten in 2008 with rents rising in all sectors.”

Yun said the credit crunch has been impacting the market over the last few months, but 2007 is already a record for commercial real estate investment.  “Tighter credit conditions will limit individual commercial real estate investment deals moving forward,” he said.  “Because capitalization rates are already very low, it is likely that commercial property prices will ease.  The era of rapid commercial property price increases has ended.”

A record $325.0 billion was invested in commercial real estate in the first 10 months of 2007, up from $306.8 billion for all of 2006; that total does not include transactions valued at less than $5 million or investments in the hospitality sector, based on analysis of data from Real Capital Analytics.

Patricia Nooney of Saint Louis, chair of the REALTORS® Commercial Alliance, said commercial real estate investment is expected to stay historically strong.  “Even with the credit crunch there’s been no significant impact on institutional investors, and it’s unrealistic to set new records every year in a cyclical business,” she said.  “There’s been a shift in investment activity to foreign buyers, who are taking advantage of the dollar’s decline relative to other currencies.  With many areas showing favorable fundamentals, commercial property in the U.S. has become very attractive to foreign investors.” 

The NAR forecast in four major commercial sectors analyzes quarterly data for various tracked metro areas.  The sectors are the office, industrial, retail and multifamily markets.  Historic metro data were provided by Torto Wheaton Research and Real Capital Analytics.

Office Market

With jobs still being created, the demand for office space remains positive and is helping to absorb the more than 30 million square feet of new space becoming available in the current quarter.  Investment grade office properties with solid income streams will be the most in demand by institutional investors, equity funds and foreign investors.

Since not all of the vacated space is being back-filled or leased, office vacancies are forecast to rise to 13.2% by the fourth quarter of 2008 from an estimated 12.9% in the current quarter; it was 12.6% at the end of 2006.  Annual rent growth in the office sector should be 8.0% this year and 2.0% in 2008, after rising 5.2% in 2006.

Projections for the fourth quarter show areas with the lowest office vacancies include New York City; Honolulu; Tucson, Ariz.; Long Island, N.Y.; Los Angeles; and Riverside, Calif., all with vacancy rates of 10.0 percent or less.

Net absorption of office space in 57 markets tracked, which includes the leasing of new space coming on the market as well as space in existing properties, is likely total 55.4 million square feet in 2007 and 43.0 million next year, but below the 81.2 million in 2006.

Office building transaction volume in the first 10 months of this year totaled a record $173.5 billion, compared with $133.5 billion for all of 2006.  So far this year foreign investors purchased $12.5 billion worth of office properties, with buyers from the Middle East and Germany accounting for half of that volume.

Industrial Market 

The weaker dollar is fueling an increase in exports, but leasing activity has declined in port distribution hubs, and vacancy rates in those markets are edging up; some users are building or renting in secondary markets.

With abundant land and relatively low concerns regarding site remediation, secondary and tertiary markets are experiencing greater interest.  So far this year, almost 16% of industrial investment has taken place outside of the 58 primary markets tracked. 

Vacancy rates in the industrial sector are projected to average 9.4% in the fourth quarter and 9.5% by the end of 2008; vacancies averaged 9.4% in the fourth quarter of 2006.  Annual rent growth will more than double to 3.3% by the end of 2007 and is seen at 1.3% a year from now, compared with a 1.4% annual gain at the end of 2006.

The areas with the lowest industrial vacancies include Los Angeles; San Francisco; Tucson; Orange County, Calif.; Portland, Ore.; and Las Vegas, all with vacancy rates of 6.1% or less.

Net absorption of industrial space in 58 markets tracked is expected total 127.4 million square feet in 2007 and 144.0 million next year, down from 205.4 million in 2006.

Industrial transaction volume in the first 10 months of 2007 was $35.8 billion, compared with $38.9 billion for all of 2006.

Retail Market

Even with a decline in consumer confidence, retail vacancy rates remain fairly stable.  Declining production of new space will help improve fundamentals in this sector during 2008.

Vacancy rates in the retail sector will probably rise to 8.9% in the current quarter from 8.0% at the end of last year, and then ease to 8.6% by the fourth quarter of 2008.  Average retail rent should grow by 2.2% this year and 1.9% in 2008, after rising 3.9% in 2006.

Retail markets with the lowest vacancies include San Francisco; Orange County, Calif.; San Jose, Calif.; Ventura County, Calif.; Washington, D.C.; and San Diego, all with vacancy rates of 5.5% or less.

Net absorption of retail space in 53 tracked markets is forecast at 18.6 million square feet for 2007 and 24.7 million next year, up from 10.5 million in 2006.

Retail transaction volume in the first 10 months of this year totaled $52.9 billion, exceeding the $46.9 billion for all of 2006.  The Southeast is the most sought-out region this year.

Multi-Family Market

The apartment rental market – multi-family housing – is experiencing increased demand from the slowdown in home sales.  With a rising population and a growing number of households, vacancies are tightening and rents are rising.

Multi-family vacancy rates are projected to average 5.4% in the current quarter, down from 5.9% in the fourth quarter of last year, and then continue to decline to 5.1% by the end of 2008.  Average rent is likely to rise 3.1% for 2007 and 3.8% next year, following a 4.1% increase in 2006.

Multi-family net absorption is expected to total 234,400 units in 59 tracked metro areas in 2007, below the 229,500 last year, but should rise to 245,800 in 2008.

The areas with the lowest apartment vacancies include Northern New Jersey, Salt Lake City, San Jose, San Diego, Nashville and Philadelphia, all with vacancy rates of 3.3% or less.

Multi-family transactions in the first 10 months of this year totaled $62.3 billion, compared with $87.4 billion for all of 2006.  The sale of buildings originally constructed as condos are being sold to multi-family investors in markets like Washington, D.C., and South Florida.  Many markets have seen condo “for sale” signs change to “apartment for lease” signs almost overnight.  Some condominium complexes are being converted into office buildings, and others are becoming mixed-use projects.

The COMMERCIAL REAL ESTATE OUTLOOK is published by the NAR Research Division for the Realtors® Commercial Alliance.  The RCA, formed by NAR in 1999, serves the needs of the commercial market and the commercial constituency within NAR, including commercial members; commercial committees, subcommittees and forums; commercial real estate boards and structures; and NAR affiliate organizations. 

Organizations in the RCA include the CCIM Institute, the Institute of Real Estate Management, the Realtors® Land Institute, the Society of Industrial and Office Realtors®, and the Counselors of Real Estate.  The RCA also provides commercial products and services.

Nearly 140,000 NAR members offer commercial services, and 73,000 of those are currently members of the RCA.

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