Two NAR Commercial Forecast: Dramatic Declines in Investment Activity Mask Respectable Fundamentals

By Scott Ian MacIntosh, Senior Economist, Commercial/Investment Real Estate

While investment in commercial real estate has decreased to levels not seen in four years, fundamentals (vacancy, rent growth, absorption) have remained relatively buoyant. There have not been any great spikes in vacancy rates nor have that many markets experienced negative rent growth. Under normal circumstances, full or near-to full occupancy coupled with positive rent growth would be ample incentive for investor interest.  Where is the disconnect?

Many analysts have assumed that capital does not exist and that banks or other sources of equity have put a halt to lending for commercial real estate. This is not the case. The decline in investment activity actually has more to do with a lack of confidence by investors and lenders who are leery about current conditions and are taking a "wait and see" attitude.  More than anything else, the decline in confidence levels is due to investor concerns and reticence about the current and future state of the economy. 

Despite these concerns, a record $427.2 billion worth of commercial real estate traded hands in 2007.  However, the vast majority of this volume occurred in the months prior to August, when the credit crunch began to impact commercial real estate.  

NAR FORECAST:  Until such time as confidence levels return to normal and investors and lenders are willing to take measured levels of risk, investment in commercial real estate in 2008 will most likely remain as much as 40% below transaction levels seen last year.

The Office Sector: Lag factor applies when new office space is added to a market....

Even when new office space is added to a market, either on a build-to-suit basis or with a significant pre-lease in place, there is often a lag period to backfill space vacated by tenants moving into newly constructed space.  Concerns about the overall economy are also causing some tenants to put their expansion /relocations plans on hold.

NAR FORECAST: There will always be some level of demand for new office space. Every market has tenants who have a need /desire for top-of-line office space. The challenge is leasing space in older office buildings in a timely and cost- effective manner.  The level of new supply in 2008 will be greater than in 2006 or 2007.  As a result the vacancy rate is forecast to increase to 13.3%.

The Industrial Market: Activity still robust in port and distribution hubs unlike manufacturing centers…

Thirty-seven percent (37%) of the investment volume in industrial real estate in 2007 involved properties in the West Region of the country, with Southern California dominating.

NAR FORECAST: International trade continues to play a pivotal role in industrial real estate dynamics. In 2007, Los Angeles outpaced almost every other primary industrial market in terms of investment transactions.  In addition, Los Angeles and neighboring Orange County boast some of the lowest industrial vacancy rates.  Could the presence of two major ports be the reason for such healthy fundamentals?

The Retail Market: New supply finally being held in check, but secondary and tertiary markets could be growing…

One aspect of the retail market often overlooked is that retail development often follows population growth. Tracking only primary markets may not give a full picture of market conditions since it omits many new retail centers in secondary and tertiary markets.  One telling sign of such activity in these markets can be seen in investment data from 2007. In the Southeast Region alone, 35% of the retail transaction volume last year occurred in secondary and tertiary markets.

NAR FORECAST: Population growth will continue to be a key determinant in the development, leasing and acquisition of retail real estate. As secondary and tertiary markets grow, it will become necessary to track commercial real estate activity in these markets as well as monitor the impact of such growth on older existing retail centers.  In addition, uncertainty resulting from the slumping housing market and recession fears will cause consumers to hold back on some expenditures even with a tax rebate.

The Multi-Family Market: Risk-averse institutional investors are attracted to multi-family …

Of the almost  $100 billion worth of multi-family properties that traded hands last year, 40% was through acquisitions from institutional investors (pension funds, life insurance companies, etc).  Private investors accounted for another 40% of the transaction volume in this sector.  Most other investment groups reduced, some dramatically, their market share in this type of real estate.

NAR FORECAST: Could institutional investors be hedging their bets on a protracted recovery in the housing sector and therefore a consistent demand for multi-family rental accommodations? Many analysts see an end to the housing crisis this year. This sector bears close watching.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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