Daily Real Estate News  |  December 19, 2007  |   Commercial Real Estate Remains Strong
The fundamentals in commercial real estate remain healthy with only slight increases in vacancy rates expected for the office and industrial sectors during 2008. However, credit restrictions have recently slowed overall investment activity, according to the latest "Commercial Real Estate Outlook"of the NATIONAL ASSOCIATION OF REALTORSŪ.

“Although vacancy rates remain relatively low for all sectors, they are expected to rise slightly in the office and industrial markets during the coming year because much of the space being absorbed is in high-quality buildings or is built-to-suit,” says NAR Chief Economist Lawrence Yun. “As a result, there is a fair amount of older space on the market, particularly in the industrial sector where obsolescence is a factor, although industrial rents are showing healthy gains. Vacancy rates in the retail and multifamily sectors are projected to tighten in 2008 with rents rising in all sectors.”

Yun says the credit crunch has been impacting the market over the last few months, but 2007 is already a record for commercial real estate investment.

“Tighter credit conditions will limit individual commercial real estate investment deals moving forward,” he says. “Because capitalization rates are already very low, it is likely that commercial property prices will ease. The era of rapid commercial property price increases has ended.”

Record Investment

A record $325 billion was invested in commercial real estate in the first 10 months of 2007, up from $306.8 billion for all of 2006; that total does not include transactions valued at less than $5 million or investments in the hospitality sector, based on an analysis of data from Real Capital Analytics.

Patricia Nooney of Saint Louis, chair of the REALTORSŪ Commercial Alliance, says commercial real estate investment is expected to stay historically strong.

“Even with the credit crunch there’s been no significant impact on institutional investors, and it’s unrealistic to set new records every year in a cyclical business,” she says “There’s been a shift in investment activity to foreign buyers, who are taking advantage of the dollar’s decline relative to other currencies. With many areas showing favorable fundamentals, commercial property in the U.S. has become very attractive to foreign investors.”

The NAR forecast in four major commercial sectors analyzes quarterly data for various tracked metro areas. The sectors are the office, industrial, retail and multifamily markets. Historic metro data were provided by Torto Wheaton Research and Real Capital Analytics.

Office Market

With jobs still being created, the demand for office space remains positive and is helping to absorb the more than 30 million square feet of new space becoming available in the current quarter. Investment grade office properties with solid income streams will be the most in demand by institutional investors, equity funds and foreign investors.

Since not all of the vacated space is being back-filled or leased, office vacancies are forecast to rise to 13.2 percent by the fourth quarter of 2008 from an estimated 12.9 percent in the current quarter; it was 12.6 percent at the end of 2006. Annual rent growth in the office sector should be 8.0 percent this year and 2.0 percent in 2008, after rising 5.2 percent in 2006.

Other projections for the office market:

• Markets with lowest office vacancies for fourth quarter: New York City; Honolulu; Tucson, Ariz.; Long Island, N.Y.; Los Angeles; and Riverside, Calif., all with vacancy rates of 10 percent 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) is likely to total 55.4 million square feet in 2007 and 43 million next year, but below the 81.2 million in 2006.

• Office building transaction volume: (in the first 10 months of this year) totaled a record $173.5 billion, compared with $133.5 billion for all of 2006. So far this year foreign investors purchased $12.5 billion worth of office properties, with buyers from the Middle East and Germany accounting for half of that volume.

Industrial Market

The weaker dollar is fueling an increase in exports, but leasing activity has declined in port distribution hubs, and vacancy rates in those markets are edging up; some users are building or renting in secondary markets.

With abundant land and relatively low concerns regarding site remediation, secondary and tertiary markets are experiencing greater interest. So far this year, nearly 16 percent of industrial investment has taken place outside of the 58 primary markets tracked.

Vacancy rates in the industrial sector are projected to average 9.4 percent in the fourth quarter and 9.5 percent by the end of 2008; vacancies averaged 9.4 percent in the fourth quarter of 2006. Annual rent growth will more than double to 3.3 percent by the end of 2007 and is seen at 1.3 percent a year from now, compared with a 1.4 percent annual gain at the end of 2006.

Other projections for the industrial market:

• Markets with lowest industrial vacancies: Los Angeles; San Francisco; Tucson; Orange County, Calif.; Portland, Ore.; and Las Vegas, all with vacancy rates of 6.1 percent or less.

• Net absorption of industrial space: (in 58 markets tracked) is expected total 127.4 million square feet in 2007 and 144 million next year, down from 205.4 million in 2006.

• Industrial transaction volume: in the first 10 months of 2007 was $35.8 billion, compared with $38.9 billion for all of 2006.

Retail Market

Even with a decline in consumer confidence, retail vacancy rates remain fairly stable. Declining production of new space will help improve fundamentals in this sector during 2008.

Vacancy rates in the retail sector will probably rise to 8.9 percent in the current quarter from 8.0 percent at the end of last year, and then ease to 8.6 percent by the fourth quarter of 2008. Average retail rent should grow by 2.2 percent this year and 1.9 percent in 2008, after rising 3.9 percent in 2006.

Other projections for the retail market include:

• Retail markets with the lowest vacancies: San Francisco; Orange County, Calif.; San Jose, Calif.; Ventura County, Calif.; Washington, D.C.; and San Diego, all with vacancy rates of 5.5 percent or less.

• Net absorption of retail space: (in 53 tracked markets) is forecast at 18.6 million square feet for 2007 and 24.7 million next year, up from 10.5 million in 2006.

• Retail transaction volume: in the first 10 months of this year totaled $52.9 billion, exceeding the $46.9 billion for all of 2006. The Southeast is the most sought-out region this year.

Multifamily Market

The apartment rental market — multifamily housing — is experiencing increased demand from the slowdown in home sales. With a rising population and a growing number of households, vacancies are tightening and rents are rising.

Multifamily vacancy rates are projected to average 5.4 percent in the current quarter, down from 5.9 percent in the fourth quarter of last year, and then continue to decline to 5.1 percent by the end of 2008. Average rent is likely to rise 3.1 percent for 2007 and 3.8 percent next year, following a 4.1 percent increase in 2006.

Multifamily net absorption is expected to total 234,400 units in 59 tracked metro areas in 2007, below the 229,500 last year, but should rise to 245,800 in 2008.

Other projections for the multifamily market include:

Markets with lowest apartment vacancies include Northern New Jersey, Salt Lake City, San Jose, San Diego, Nashville and Philadelphia, all with vacancy rates of 3.3 percent or less.

Multifamily transactions in the first 10 months of this year totaled $62.3 billion, compared with $87.4 billion for all of 2006. The sale of buildings originally constructed as condos are being sold to multifamily investors in markets like Washington, D.C., and South Florida.

Many markets have seen condo “for sale” signs change to “apartment for lease” signs almost overnight. Some condominium complexes are being converted into office buildings, and others are becoming mixed-use projects.

— REALTORŪ Magazine Online

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