In Focus

Commercial Market Trends - Focus on Retail and Multi-family

by George Ratiu, NAR Research

Last month in this column we looked at how the financial crisis on Wall Street and a slowing economy have been affecting the office and industrial sectors of commercial real estate. This month we examine the impacts on retail and multi-family properties.

Retail Sector

Over the last few years, healthy job growth and a steadily, albeit slower, expanding economy spurred demand for office and industrial space. Consumer spending was strong, fueled by credit availability. Consumer spending accounts for 70 percent of economic activity and has been the main driver of economic growth over the past few years. But as employment turned negative at the beginning
of this year, and as credit availability dried up due to the financial crisis that emerged, consumer spending has slowed considerably. In addition, rising prices for most consumer goods, due primarily to increased fuel costs, have also curtailed consumer spending. These factors have rippled through the retail sector of the commercial real estate market.

Consumer spending decreased 3.1 percent in the third quarter of this year, and is expected to continue on a downward path in the fourth quarter as well This deceleration is in marked contrast to the 3 to 4 percent real growth in consumer spending during the past 5 years. Consumers have trimmed their spending on all fronts, except necessities. As a result, the retail sector is clearly feeling the pressure. Demand for retail space is dropping, with many companies closing retail outlets across the country.

However, the pace of completions coupled with declining demand, is causing decreases in net absorption. The national vacancy rate is moving up and is projected to reach 10.1 percent by the fourth quarter of 2008. Some of the hardest hit cities are in the Midwest. Topping the list is Detroit, MI with a vacancy rate of 17.7 percent for the third quarter of 2008. Columbus, OH recorded the second highest vacancy rate, at 16.2 percent, followed by Fort Worth, TX (14.2%), Indianapolis, IN (14.1%), and Kansas City, MO (13.6%).

On a positive note, most Southern California markets are posting improvements in vacancy rates. For the third quarter of 2008, Los Angeles posted a vacancy rate of 5.0 percent, while San Diego's vacancy rate was 6.6 percent. Orange County remains on the list of markets with the lowest vacancy rates in the country, at 3.9 percent.

Given the increase in vacancy rates and the number of store closings, average retail rent is expected to have remained virtually flat in the third quarter of 2008, at 0.1 percent. For the year, rent growth will likely show only a moderate 1.2 percent increase, compared with the 3.2 percent gain for 2007.

It is unlikely that the fourth quarter, which encompasses the traditional holiday shopping season, will provide much relief. While gas prices have been declining, the economic slowdown prompted by the financial crisis is leading to continued job losses and deterioration in consumer confidence. Furthermore, retailers are responding to expected lower sales by trimming orders and inventories.

The Multi-family Sector

While the residential market is still dealing with delinquent mortgages and foreclosures, the multi-family sector is feeling some positive side-effects. A good number of potential first-time home buyers
are waiting out the current economic and housing conditions, and choosing to rent. In addition, in markets with significant foreclosures, displaced homeowners are renting units in multi-family buildings. As a result, the multi-family market is likely to be the least impacted of the commercial property types.

Nationally, the vacancy rate was 5.4 percent for the third quarter of 2008, unchanged from the previous quarter. There are several markets, however, where the availability is significantly lower, making for a "landlord's market." Newark, NJ and Pittsburgh, PA both share the lowest vacancy rate for the third quarter, at 2.2 percent. Other markets with low vacancy rates are Minneapolis, MN and Philadelphia, PA, each at 2.8 percent. San Diego, CA rounds out the list, with a vacancy rate of 3.0 percent for the quarter. Markets where vacancy rates are higher than the national average include Jacksonville, FL at 8.5 percent, Phoenix, AZ at 8.1 percent, as well as Houston and Fort Worth, TX at 7.7 percent and 7.2 percent, respectively.

The number of multifamily completions remains relatively high, despite a slight drop in the third quarter of 2008. A major factor in completions continues to be the conversion of condominium projects into multi-family rental units. This is a particularly notable trend in markets that experienced increases in condominium construction over the past five years, such as Washington D.C and Miami. The pace of completions is matched, however, by positive net absorption. In turn, rent growth in the multi-family sector continues on a moderate, but steady pace. For the third quarter of 2008, rents are up 1.1 percent.

In the short run, the multi-family sector is slated to remain stable. By the end of 2008, the vacancy rate is expected to be 5.5 percent, only slightly higher than the 5.4 percent during 2007.

Conclusion... and for more information

The credit crisis has hit the commercial real estate market harder than the residential sector. The lack of liquidity in capital markets is causing companies to cancel or postpone many commercial real estate transactions. Commercial market fundamentals, which have held up fairly well for the first part of the year, are showing signs of decline. Demand for space, particularly in the retail sector is down and vacancy rates are trending upward. The recent bankruptcy of Circuit City highlights the difficulty of retailers to operate in the current economic recession. The continued job losses are likely to also impact retail sales, especially during the crucial holiday shopping season.

Consumer spending will continue to tighten for the foreseeable future, with further dampening of the retail market. The outlook for the apartment rental market is a bit brighter; it should stay fairly positive, with a moderate level of growth.

For more information about commercial real estate sectors, visit www.realtor.org/research.