Fundamentals Holding in Commercial Real Estate
Commercial real estate market fundamentals are fairly stable, although investment is waning following a record year in 2007, according to the latest COMMERCIAL REAL ESTATE OUTLOOK of the National Assn. of REALTORS®.
NAR Chief Economist Lawrence Yun (shown at right) said the commercial real estate market is holding essentially even. “We’re seeing no significant changes in vacancy rates or rent growth, so the fundamentals in commercial real estate still seem to be respectable,” he said. “Under normal circumstances, near-full occupancy coupled with positive rent growth would be of strong interest to investors, but we’re not seeing that. The credit crunch has filtered into the commercial real estate market.”
Patricia Nooney of St. Louis, chair of the REALTORS® Commercial Alliance Committee, said the investment cycle appears to be turning. “It looks like investors are taking a wait-and-see attitude,” she said. “Even with fairly stable fundamentals and capital available from institutional investors, it appears investor confidence has declined, and some private investors have had problems obtaining financing. Commercial real estate investment set a new record in 2007, but now that we’re in a period of economic uncertainty, transaction volume is likely to decline.”
Investment in commercial real estate in 2007 was $427.2 billion, up 39.2% from the previous record of $306.8 billion in 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. NAR projects the investment dollar volume this year could drop by 30 to 40%, comparable to 2006 levels.
The NAR forecast in four major commercial sectors analyzes quarterly data for various tracked metro areas. The sectors are the office, industrial, retail and multi-family markets. Historic metro data were provided by Torto Wheaton Research and Real Capital Analytics.
There is a lag factor in the current office market to backfill space by tenants who moved into newly constructed space. At the same time, concerns about the overall economy are causing some tenants to put expansion or relocation plans on hold. These present a challenge to timely and cost-effectively lease space in older office buildings.
Since the level of new supply will be greater this year, office vacancies are expected to rise to 13.3% in the fourth quarter from 12.5% in the last quarter of 2007. Annual rent growth in the office sector is forecast at 3.5% in 2008, following an 8.0% gain last year.
Estimates for the first quarter show areas with the lowest office vacancies include New York City; Honolulu; Long Island, N.Y.; and San Francisco, all with vacancy rates of 9.4% 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, should total 38.5 million square feet in 2008, down from 57.3 million last year.
Office building transaction volume in 2007 totaled a record $211.0 billion, compared with $133.5 billion for 2006. Equity funds accounted for 40% of office investment last year. Foreign investors purchased a record $17.7 billion in office buildings last year.
Industrial activity remains strong in port and distribution hubs, with relative weakness around many manufacturing centers. International trade continues to play a pivotal role in industrial real estate.
Vacancy rates in the industrial sector will probably average 9.6% in the fourth quarter of 2008, up from 9.4% in the same period last year. Annual rent growth is projected at 3.3% by the fourth quarter, down from 3.6% at the end of 2007.
The areas with the lowest industrial vacancies include Los Angeles; San Francisco; Tucson, Ariz.; Salt Lake City; Orange County, Calif.; and Portland, Ore., all with vacancy rates of 6.1% or less. Los Angeles is expected to remain a landlord’s market for the next four to five years.
Net absorption of industrial space in 58 markets tracked is likely to total 134.7 million square feet in 2008, up from 120.2 million last year. Industrial transaction volume in 2007 was a record $46.0 billion, compared with $38.9 billion in 2006.
The supply of new retail space is finally being held in check, although secondary markets might be growing because new space often follows population growth. As secondary and tertiary market populations continue to grow, it will become necessary to track those markets in addition to monitoring older retail centers.
Vacancy rates in the retail sector are expected to decline to 8.8% in the fourth quarter from 9.2% in the fourth quarter of 2007. Average retail rent is forecast to grow by 1.4% in 2008, compared with a 3.2% rise in 2007.
Retail markets with the lowest vacancies include Orange County, Calif.; San Francisco; San Jose, Calif.; Washington, D.C.; Las Vegas; Honolulu; and Los Angeles, all with vacancy rates of 5.9% or less.
Net absorption of retail space in 53 tracked markets is forecast at 24.8 million square feet this year, up from 11.1 million in 2007. Retail transaction volume in 2007 totaled a record $71.6 billion, up from $46.9 billion in 2006. REITs accounted for a quarter of retail transaction volume last year.
The apartment rental market – multi-family housing – is attracting risk-averse institutional investors. Of the record $98.6 billion spent in this sector last year, 40% of acquisitions were from institutional investors such as pension funds and life insurance companies. Private investors were equally active, accounting for another 40% of transactions.
Many potential first-time home buyers continue to rent, placing downward pressure on vacancy rates and upward pressure on rents. The number of new multilfamily units remains relatively high, due in part to the conversion of condo projects into rental buildings – notably in the Washington, D.C., area and South Florida.
Multi-family vacancy rates should average 4.8% in the fourth quarter, down from 5.1% in the fourth quarter of 2007. Average rent is seen to rise 5.3% in 2008, up from a 3.1% increase in 2007.
Multi-family net absorption is estimated at 245,800 units in 59 tracked metro areas in 2008, up from 234,400 last year.
The current national vacancy rate is 4.7%, below the 5.0% level which is considered landlord’s market. The areas with the lowest apartment vacancies include Northern New Jersey, San Jose, Miami, Salt Lake City and San Diego, all with vacancy rates of 2.9% or less.
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.
More than 80,000 NAR members offer commercial services, and 60,000 of those are currently members of the RCA.
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