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Commercial Sector: Making Strides in a Jumpy Economy

January 30, 2013

Are the weak U.S. jobs numbers and the debt headaches in Europe making your clients uneasy about commercial real estate performance? Don’t worry, says Lawrence Yun, chief economist for the National Association of REALTORS®. Net absorption is rising because the economy has added nearly 4 million jobs since 2009. Combine that with very limited new construction over the same period, and “even moderate demand for commercial space will help lower vacancy rates and slowly push up rents,” he says.

Pull backs in job growth may flatten demand for commercial real estate for the remainder of 2012, but economic uncertainty may actually benefit the investment, says Kenneth Riggs, CRE, chairman and president of Real Estate Research Corp. “Commercial real estate is a tangible asset with a believable income, which makes it attractive to investors, and it has not had the major swings in value we’ve seen in the stock market recently.” European problems are also making U.S. properties more attractive as a safe haven for foreign investors, he notes.

Yun is also confident that “there is no recession overthe horizon for the U.S.” Like the Federal Reserve, he anticipates “moderate” economic growth of between 2 and 2.5 percent annually for 2012 and 2013. Why? Despite a recent slowing in business spending, “corporations are sitting on a massive $2 trillion cash reserve,” he says. Consumer spending is also rising, and Yun expects jobs to increase by 2.5 million next year. “A lot of the commercial real estate’s performance in 2013 depends on how quickly we can grow employment,” says Matt Wisniewski, with the RE/MAX Commercial Group in Lansing, Mich.

Still, in all but the strongest gateway markets, uncertainty about the election, job growth, and Europe is taking its toll on landlord confidence, says Ken Ashley, CCIM, SIOR, senior director of Cushman & Wakefield’s Tenant Advisory Group in Atlanta. Even though Atlanta’s office vacancies are declining, especially in the CBD, landlords that were talking about raising rents a couple of months ago are now pulling back. “When you’ve just come through a string of rapids, you’re going to be conservative about how you approach the next bend in the river,” he says. “There are not many broad-based asset-class winners,” agrees Riggs, “but if I had to bet on a horse in this economy, its name would be commercial real estate.”

Progress at Different Paces

Far ahead of the rest of the commercial property field is multifamily. Yun expects apartment vacancies to drop to 4.6 percent nationally by the end of 2012. Even a significant uptick in construction this year won’t diminish absorption and rent growth, he adds. In Southern California, “multifamily is strong at all three levels—Mom and Pop, mid-sized privately held properties, and large complexes owned by REITs or pension funds,” reports Jeffrey Peldon, operating partner for two Keller Williams Realty/ KW Commercial offices in Los Angeles. There’s also new construction, with previously entitled condominium properties now being built as rental apartments, he says.

Industrial’s recovery is certainly no match for multifamily, but it is showing signs of strengthening this year and promises even better returns in 2013, predicts Yun. ”We’re seeing a lot more interest and activity in buying and leasing industrial space,” says Wisniewski. “It’s not pretty, but it’s a lot less ugly.”

Yun expects industrial rents to rise by 2.3 percent in 2013 and vacancies to drop to 10.7 percent nationwide. “It’s still a tenant’s market, but good locations are starting to resist rent abatements,” reports Charlie Foxworth, SIOR, CCIM, president of RE/MAX Commercial in Beaumont, Texas. The Gulf Coast of Texas is benefiting from a booming world market for oil and natural gas, he explains. Nationwide growth in U.S. manufacturing, which has grown for 34 straight months through May 2012, should also strengthen warehouse demand.

In many markets, retail is still struggling to shake off the recession’s woes, but tenants’ confidence and willingness to lease more space is growing. “Most of the retail tenants I’ve talked to recently are committed to expanding or relocating to better space. And they aren’t resistant to quoted rents like they were a year ago,” says William Poteet, GRI, owner of Poteet Properties Inc., in Naples, Fla.

“Retail is always driven by employed people,” says John Orr, CCIM, with Colliers International in Charleston, S.C. Case in point: Charleston’s diversified economy, including a new Boeing plant building the Dreamliner aircraft, has helped push retail vacancies down to single digits in some submarkets and prompted six new shopping center starts. Strict zoning regulations that prevented retail overexpansion before the downturn has also kept retail strong, says Orr.

While office is improving more slowly than other property types, vacancies are falling and will probably drop below 16 percent in 2013, says Yun. “Many cities aren’t replenishing their office inventories, which is a benefit now, but may catch up with us eventually,” says Ashley. He also notes that vacancy numbers can be deceiving. Some space is functionally unsuited to the new shared and mobile office environments most companies want today.

Limited Funds Keep Brakes on Transactions

If there is one shadow over the positive outlook for commercial real estate, it is a lack of financing, especially for transactions under $2.5 million. “The private investor is being squeezed out by the lending community,” says Orr. “FDIC regulations and Dodd-Frank are holding back credit, especially among smaller community banks,” agrees Yun.

The 2012 NAR Commercial Lending Survey found that 67 percent of commercial members had a deal fail in the last year because of financing issues. “There’s not a lot of incentive to lend on smaller deals since they require almost as much paperwork as larger transactions,” notes Wisniewski.

An exception is multifamily, “which is a regional bank business,” says Peldon. Owners of existing properties are also taking advantage of lower interest rates to refinance and increase cash flow. “Even if an owner takes no cash out, income will increase because of lower loan coasts,” says Peldon. “With the weakness in investment and national banks returning, we expect to see bank lending decline at least through 2012,” says Riggs. However, he notes, as one lending door closes, another opens including life companies, regional banks, and credit unions. “I’ve seen credit union deals as large as $7.5 million. If the loan amount is too large, several credit unions will work together,” says Foxworth. (Go to By the Numbers column in the this issue for more on lending.)

A Brighter, If Not Brilliant, Future

While the recovery may still be bumpy in the next 18 months, most commercial real estate practitioners expect 2013 to be a good year for business. “Once we get through the election and have a sense of direction, companies that are sitting on cash will be more willing to take additional space,” predicts Foxworth.

“The industry is still operating from a position of fear, but when the pendulum swings toward hope — as I think it will later in 2013 — we’ll see a more robust recovery for commercial real estate,” concludes Ashley.


Commercial Outlook by Property Type

(as of May 2012)

  2011 2012 2013
MULTIFAMILY
Vacancy
Completions (units)
Rent
5.2%
37,678
2.2%
4.4%
82,492
4.0%
4.3%
156,643
4.1%
OFFICE
Vacancy
Completions (00,000s sq. ft.)
Rent
16.6%
12.3
1.6%
16.2%
16.2
2.0%
15.8%
30.9
2.5%
RETAIL
Vacancy
Completions
Rent
12.5%
4.9
–0.2%
11.2%
6.0
0.8%
10.7%
16.9
1.3%