Economists' Commentary: Commercial Real Estate

March 4, 2009

By George Ratiu, Research Economist

The economic recession continues to take a toll on the commercial real estate sector. This is particularly painful in the office market, where corporate cost-cutting is leading to massive job losses, and in turn, to significantly diminished demand for space. In January alone, there were 598,000 job losses nationwide. These come on the heels of 577,000 jobs lost in December and 597,000 jobs lost in November of 2008. Of the January losses, 42,000 were from the financial sector and 121,000 came from professional and business services. Not surprisingly, the unemployment rate in January reached 7.6 percent, a rate not seen since September 1992.

In addition, major banks continue to post significant losses and appeal for government assistance, fueling declines in investor confidence. This factor was illustrated by Monday's decline of the Dow Jones Industrial Average below the 6800 mark, the lowest point since 1997. In turn, financial liquidity continues to pose a serious challenge to major office deals and refinancing.

On the supply side-underscoring the traditional resilience of commercial real estate-new office construction remained strong in 2008. In fact, the volume of office completions for the year exceeded the volume in 2007 by 12.3 million square feet. The fourth quarter 2008 recorded a significant 23.4 million square feet of new office space.

The one-two combination punch of dwindling demand and considerable new construction is providing quite a blow to the office sector, as evidenced by negative net absorption and rising vacancy rates. Net absorption is projected to reach a negative 15.1 million square feet in the first quarter of 2009, and continue on a downward path for the remainder of the year.

With demand declining and rising availability of new office space, the vacancy rate is estimated to rise to 14.7 percent in the first quarter of this year. Furthermore, the vacancy rate is expected to continue growing toward 18.0 percent by the end of 2009. Office markets with large concentrations of office employment and slower pace of new completions continue to maintain lower vacancy rates. New York still tops the list of markets with the lowest office vacancy rates, with a vacancy rate of 7.9 percent for the first quarter of 2009. This is in contrast to the metro area's previous quarter vacancy rate of 6.8 percent. In addition to New York, the only other market posting single-digit vacancy rates is Honolulu, HI (9.8%).

Regionally, the first quarter is showing distress in several office markets. Phoenix, AZ displaces Detroit at the top of the list of highest vacancy rates, with 23.4 percent. Detroit, MI posts the second-highest vacancy rate, at 22.8 percent. However, there are several markets in the South and Western regions with high vacancy rates. West Palm Beach, FL, along with Dallas, Riverside and Tampa are experiencing vacancy rates at or over 20.0 percent. Meanwhile, San Diego and Jacksonville are seeing availability rates of 19.7 and 19.4 percent, respectively.

In light of the economic conditions and rising vacancies, rent growth for office space is declining. Office rents declined 0.4 percent in 2008, in sharp contrast to the 8.0 percent growth during 2007. Rents are expected to decline 4.2 percent during 2009.

Office fundamentals are contracting in response to the economic recession. The forecast for the next quarter is not likely to improve, especially considering the expectation of additional job losses.

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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