Commercial Real Estate Was Strong for 2007 and Expected to Fare Well in 2008

According to the latest “Commercial real Estate Outlook” of the NATIONAL ASSOCIATION OF REALTORS ©,the fundamentals in commercial real estate in the United States remain healthy with only slight increases in vacancy rates expected for the office and industrial sectors during 2008. Although the credit crunch impacted the market over the last few months, 2007 was a record for commercial real estate investment. $325 billion was invested in commercial real estate 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.


Although vacancy rates remain relatively low for all sectors, they are expected to rise slightly in the office and industrial markets during 2008 because much of the space being absorbed is in high-quality buildings or is built-to-suit. This means that there is a fair amount of older space on the market, particularly in the industrial sector where obsolescence is a factor. However, industrial rents are showing healthy gains which should alleviate the supply. Vacancy rates in the retail and multifamily sectors are projected to tighten in 2008 with rents rising in all sectors.

Tighter credit conditions will limit individual commercial real estate investment deals moving forward. With Cap rates already fairly low, it is likely that commercial property prices will feel pressure.

As a result of the weaker dollar and favorable fundamentals, commercial property in the U.S. has become very attractive to foreign investors and will remain so for some time.

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 last quarter of 2007. Investment grade office properties will be the most in demand by institutional investors, equity funds and foreign investors, especially from the Middle East and Germany.

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 fourth quarter of 2007; it was 12.6 percent at the end of 2006. Annual rent growth in the office sector was predicted to be 8.0 percent in 2007 and 2.0 percent in 2008, after rising 5.2 percent in 2006.

In 57 markets tracked in the nation by Real Capital Analytics, which includes the leasing of new space coming on the market as well as space in existing properties, the net absorption of office space is likely to total 55.4 million square feet in 2007 and 43 million in 2008. In the first 10 months of 2007 alone, office building transaction volume totaled a record 173.5 billion. Compare this with $133.5 billion for all of 2006.

INDUSTRIAL MARKET

With abundant land and relatively low concerns regarding site remediation, secondary and tertiary markets are experiencing greater interest in the USA. By the end of the third quarter of 2007, 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 of 2007 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.

In 58 markets tracked, the net absorption of industrial space was expected to total 127.4 million square feet for 2007 and 144 million for 2008. The total 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 were forecast to rise to 8.9 percent in the last quarter of 2007 from 8.0 percent at the end of 2006, and then ease to 8.6 percent by the fourth quarter of 2008. Average retail rent should grow by 2.2 percent for 2007 and 1.9 percent in 2008, after rising 3.9 percent in 2006.

The Net absorption of retail space (in 53 tracked markets) was forecast at 18.6 million square feet for 2007 and 24.7 million for 2008, up from 10.5 million in 2006. The Retail transaction volume in the first 10 months of 2007 totaled $52.9 billion, exceeding the $46.9 billion for all of 2006. The Southeast was the most sought-out region for 2007.

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 were projected to average 5.4 percent in the last quarter of 2007, down from 5.9 percent in the fourth quarter of 2006, and then continue to decline to 5.1 percent by the end of 2008. Average rent was expected to rise 3.1 percent for 2007 and 3.8 percent for 2008, following a 4.1 percent increase in 2006.

Multifamily net absorption was projected 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.

Multifamily transactions in the first 10 months of 2007 totaled $62.3 billion, compared with $87.4 billion for all of 2006. Many 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.

Sources: National Association of Realtors
Real Capital Analytics
The Wall Street Journal Real Estate Review