The third quarter of 2009 brought signs of relief to a U.S. economy fighting to emerge from what has been coined the Great Recession. Most measures of economic activity moved in upward trends-gross domestic product turned positive after four quarters of decline; industrial production gained; stock market indices have been surging.The national economy has clearly been taking a toll on the Industrial and Office markets fundamentals. Construction levels are at a standstill. The only mitigating factor for the office marketplace is a slightly higher level of leasing activity than in the industrial market. However, the office market has more sublease space available than the industrial market and, currently, it is a strong buyer's market. Leasing activity is well below historical averages for most property types, and tenant concessions are the norm. Even the more resilient multi-family sector has experienced higher vacancies and decreases in rents.
But not all is doom and gloom. While the economy is slowly coming back to life, several issues continue to cast long shadows over prospects of recovery in general and commercial real estate, in particular. While most of the components that contribute to GDP showed increases, nonresidential investment was down 4.1 percent, with investment in commercial structures declining 15.2 percent.
Vacancies
In the third quarter of this year, vacancies in most of the markets tracked posted double-digit rates. Overall office vacancy was 16.1 percent - continuing its rise since the beginning of the year. Multifamily properties posted a lower overall vacancy rate of 7.3 percent in the third quarter, but that is still higher than in the previous two quarters.
Rent Growth
Trends in rent growth have been on an upward, although still in negative territory. Growth in rents improved steadily for industrial and retail properties through the year. Office rent growth declined 0.9 percent from the 2nd to the 3rd quarter. Only the multifamily sector showed continual negative growth in rent over the past three quarters.
Transactions
On the transaction side, sales activity has been positive, but slow and stuck in a vicious cycle where lack of credit reinforced a negative spiral. During the third quarter of 2009, loan balances at commercial banks declined 2.8 percent from the previous quarter, the largest percentage drop in 25 years. Lending contracted mostly sharply for construction and development loans, which were down 8.1 percent from the second quarter, to $492 billion. At a volume of $1.27 trillion, commercial and industrial loans posted the next largest decline-6.5 percent.
Recoveries in global economies and rising international cash reserves are prompting investors to start looking for deals. Transaction activity during the third quarter of 2009 rose 27.4 percent, with 677 major properties exchanging hands for a total of $13.1 billion. The advance in commercial property sales was driven by an 85 percent jump in office sales. The volume of retail and hotel sales also increased noticeably, by 46 percent and 40 percent, respectively. Apartment transactions were up 12 percent, while industrial sales declined 32 percent.
Behind the Numbers
At the heart of these issues lies employment. Payroll employment has been on a steep decline for the past 22 months. Over that period, 7.3 million jobs have been lost. The unemployment rate jumped from 7.2 percent in December 2007 to 10.2 percent in October of this year.
Looking Ahead
How are these factors impacting the outlook for commercial real estate? In brief, it will be a slow and difficult road towards stabilization over the next several quarters, although along that road will be modest signs of improvement. But the stabilization and improvements will not be spread evenly across property types or geographical markets. Whereas office properties struggle with high vacancies, declines in rents for industrial space are expected to grow. And while demand for apartments is projected to rise in 2010, challenges continue to mount for distressed hotel and retail properties.
For the fourth quarter 2009, net absorption is expected to decline 18.7 million square feet for office space and 74.9 million square feet for industrial properties. Retail space is likely to post 4.4 million square feet of negative net absorption. Even apartments are expected to experience a quarterly decline of 44.7 thousand units in net absorption.
In tandem with the decline in demand, available space is growing across all property types. Vacancy rates for the fourth quarter are expected to hit 17.0 percent for office properties, 14.2 percent for the industrial sector, 12.6 percent for retail and 7.8 percent for multi-family. In order to attract or retain tenants, landlords are reducing rents. By the end of 2009, rent rates are expected to be down 12.1 percent for office properties, 10.8% for industrial, 1.3 percent for retail and 4.1 percent for apartments.
Nonetheless, in an encouraging sign for commercial real estate, the commercial mortgage backed securities (CMBS) market regained a pulse around midyear, sparked in part by the government's TALF program, with over $1.2 billion issued during the third quarter
Commercial real estate is facing a quick-changing landscape where maturing debt, loan modifications, lower prices and private investment currently vie for a foothold. Central to any market stabilization and sustained recovery is the issue of employment and credit availability. More to the point, a positive shift in employment and financing activity are both needed to place commercial real estate on solid ground.
Source: NAR - by George Ratiu, Research Economist
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