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OFFICIAL MAGAZINE OF THE NATIONAL ASSOCIATION OF REALTORS®

Daily Real Estate News  |  September 18, 2007  |   Healthy Outlook Continues for Commercial Real Estate
Most commercial real estate markets are enjoying relatively low vacancy rates and healthy rent growth from a fundamentally sound economy, according to the latest Commercial Real Estate Outlook of the NATIONAL ASSOCIATION OF REALTORS®.

“Commercial real estate responds to economic growth and job creation, which have been fairly strong over the past two years and have created the need for additional commercial space,” says NAR Senior Economist Lawrence Yun. “These fundamentals will continue to support commercial real estate markets in 2008. There has not been much overbuilding in the commercial sectors, and investors are more diverse.”

Commercial Sector Hits Record Highs

Yun says pricing for some commercial real estate has been at a record high, and capitalization rates have been at historic lows. “Normalization of prices may be occurring, but it isn’t clear what the definition of normal might be in the current market given the repricing of risk in the capital market,” he notes. “In short, the difference between the cash flow on a typical property and its price is close to a maximum, indicating prices may even out.”

A record $257 billion was invested in commercial real estate in the first seven months of 2007, up from $146.7 billion in same period in 2006 that total does not include transactions valued at less than $5 million, or of investments in the hospitality sector.

NAR Forecast

Cindy Chandler of Charlotte, N.C., chair of the REALTORS® Commercial Alliance, says there have been some problems recently regarding the availability of capital.

“Overreaction to credit concerns in the financial markets could limit the availability of capital needed by private investors, but overall the situation does not appear to have significantly impacted institutional-grade commercial properties,” she says. “We're returning to the fundamentals and deal structuring of the mid '90s, and may see some dampening in investment activity, but there is a lot of momentum in commercial real estate.

Chandler predicts the commercial sectors to hold at a healthy level of activity in most of the nation. “Although there could be some slowing as a result of postponed transactions and delays in decision making,” she says.

The following is NAR's forecast for the four major commercial sectors, based on analyses of quarterly data for various tracked metro areas provided by Torto Wheaton Research and Real Capital Analytics.

Office Market

The office sector is the most favored by investors, with strong rent growth this year. The cost of steel and other factors have helped minimize speculative construction in most markets. The demand for space is expected to remain strong into 2008, and areas with strong job growth are benefiting the most. Older vacated space is lagging on the market in some cities.

Here are some additional projections for the office market:
  • Vacancy rate: expected to edge up to an average of 12.9 percent in the fourth quarter from 12.5 percent in the fourth quarter of 2006, and then dip to 12.4 percent by the end of 2008. Projections for the third quarter show areas with the lowest office vacancies include New York City; Ventura County, Calif.; Seattle; Los Angeles; Honolulu; and Long Island, N.Y., all with vacancy rates of 9.4 percent or less.
  • Annual rent growth: forecast at 6.1 percent in 2007 and 3.1 percent next year, after rising 5.2 percent in 2006.
  • Net absorption of office space: 53.8 million square feet this year and 65.1 million in 2008, compared with 78 million last year. This projection is based on 57 markets and includes the leasing of new space coming on the market as well as space in existing properties.
  • Office building transaction volume in the first seven months of 2007: $147 billion, a record for the period, which is 53 percent higher than the same period in 2006. Equity funds accounted for 43 percent of office building purchases, followed by private investors at 21 percent.

Industrial Market

Although the main driver for the industrial market continues to be the need for warehouse and distribution space, particularly in ports and distribution hubs, the rebirth of the technology sector is fueling demand for flex space. A marked increase has occurred in markets such as San Jose, Calif.; Portland, Ore.; Seattle; and Phoenix.

Much of the new industrial supply has been on a build-to-suit basis, and building obsolescence remains a factor for distribution facilities. With tightening availability in many primary markets, users are starting to show greater interest in secondary markets. Here are some more forecasts for the industrial market in the coming year:
  • Vacancy rates: likely to average 9.6 percent in the fourth quarter and 9.4 percent by the end of 2008, compared with 9.4 percent in the fourth quarter of 2006. The areas with the lowest industrial vacancies include Los Angeles; Albuquerque; Tucson; Orange County, Calif.; Portland, Ore.; and San Francisco, all with vacancy rates of 5.4 percent or less.
  • Annual rent growth: expected to more than double to 3.9 percent by the end of this year, and is estimated at 3.7 percent in the fourth quarter of 2008 up from a 1.4 percent annual rise at the end of last year.
  • Net absorption of industrial space: (based on 58 markets tracked) will probably total 125 million square feet in 2007 and 165.6 million next year, down from 202.8 million in 2006.
  • Industrial transaction volume in the first seven months of 2007: $26.8 billion, up 13 percent from the same period in 2006. Private investors accounted for 36 percent of industrial purchases, followed by equity funds at 25 percent.

Retail Market

Recovery in the retail market has been held back by high levels of new supply, but developers appear to have gotten the message. The majority of new space on the market today is in nonregional malls, but new available space should see marked declines in 2008. Credit problems have not yet impacted retail sales, but will be watched closely.

NAR also made the following predictions for the retail market:
  • Vacancy rates: projected to rise to 9.3 percent in the fourth quarter from 8.1 percent at the end of 2006; vacancies are forecast at 8.9 percent by the end of next year. Retail markets with the lowest vacancies include San Francisco; Orange County, Calif.; San Jose, Calif.; Ventura County, Calif.; Washington, D.C.; and Las Vegas, all with vacancy rates of 5.1 percent or less.
  • Average retail rent: expected to rise 2.9 percent in 2007 and 1 percent next year, following a 3.9 percent increase in 2006.
  • Net absorption of retail space: (based on 53 tracked markets) 12.1 million square feet this year and 19 million in 2008, up from 10.7 million last year.
  • Retail transaction volume in the first seven months of 2007: $37.4 billion, up from $22.3 billion in same period in 2006. Private investors accounted for 35 percent of transaction volume, followed by institutional investors at 22 percent and foreign investors, 18 percent.

Multifamily Market

The apartment rental market — multifamily housing — anecdotally appears to be impacted by an influx of single-family homes being offered for rent, cutting into the demand for apartment rentals. In addition, condos are being converted into rental units, particularly in markets such as Washington, D.C., and several areas of Florida.

At the same time, potential first-time home buyers are hesitant and staying in the rental market, supporting multifamily fundamentals until the lure of homeownership returns, the housing cycle changes, and more buyers enter the housing market. Other projections for the multifamily market include:
  • Vacancy rates: expected to average 5.9 percent in the fourth quarter, the same as the fourth quarter of 2006, and then ease to 5.6 percent by the end of next year. The areas with the lowest apartment vacancies include Northern New Jersey, Salt Lake City, Philadelphia, Pittsburgh, Los Angeles, Minneapolis, and Nashville, all with vacancy rates of 2.7 percent or less.
  • Average rent: projected to increase 2.9 percent this year and 3.8 percent in 2008, after a 4.1 percent rise last year.
  • Multifamily net absorption: expected to total 209,200 units in 59 tracked metro areas this year, down from 229,400 in 2006, but increase to 234,400 in 2008.
  • Multifamily transactions in the first seven months of 2007: $46.3 billion, compared with $41.5 billion in the same period in 2006. Half of the purchases were by private investors, while condo converters accounted for only three percent of acquisitions.

— REALTOR® Magazine Online

For more economic news and research reports, visit NAR's Research division at REALTOR.org.

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