Measured Improvement in Commercial Sectors Expected

November 14, 2011

Despite sluggish economic growth and continuing concerns over high unemployment and the struggling housing market, the modest but steady improvement in commercial real estate in 2011 is expected to continue into 2012 and 2013, analysts told REALTORS® yesterday.

There’s some positive news, NAR Chief Economist Lawrence Yun said. Corporations are sitting on large cash reserves. The stock market is performing relatively well. Job gains—although still low—are slowly improving. And foreign buyers, attracted to the investment opportunities here, are in the hunt for properties, Yun explained. What’s more, investors appear to be looking to real estate as an inflation hedge, in part because the other traditional inflation hedges, gold and silver, are hovering at historically high prices.

The weak housing market, with financially strapped owners transitioning to rentals and young adults doubling up with family or friends rather than buying, is helping to fuel activity in multifamily properties, which is the strongest by far of the commercial property sectors, Yun said.  

For the second year in a row, absorption of inventory is far outpacing completions of new units in the sector, helping to keep supply and demand in balance. Almost 170,000 units were absorbed in 2011, compared to completions of about 38,000 units. In 2010 the spread was even wider. As a result, vacancies continue to drop and rental rates continue to rise. Yun is forecasting multifamily vacancies to drop to 4.6 percent in 2012 from 5.3 percent this year, and to drop to 4.5 percent in 2013. The rental rate, at a median of $1,066 per unit, is expected to increase 3.5 percent next year and 3.8 percent in 2013.

Offices are seeing improving fundamentals as well, with absorptions at about twice that of completions. Yun is forecasting vacancies to drop from 17.3 percent this year to 16.3 percent next year and 15.9 percent in 2013, with the 2011 rental rate of just under a median of $28 per square foot increasing 1.7 percent in 2012 and 2.4 percent in 2013.

In the industrial sector, absorptions are three times as high as completions, but vacancy rates will rise at least for another year. In his forecast, Yun says vacancies will rise from about 11.1 percent to 11.9 percent next year and then drop back down to 11.1 percent in 2013. The rental rate, at a median of $4.60 per square foot, will rise 1.8 percent in 2012 and 2.34 percent in 2013.

The retail sector is struggling the most, with continuing negative absorption and vacancy rates still heading up. Yun is forecasting vacancies to rise from 11.1 percent to 12.2 percent next year before dropping to 11 percent in 2013. The rental rate, at just under a median of $19 a square foot, is projected to rise 0.7 percent next year and 1.4 percent in 2013. Absorption could pick up if there's improvement in the dollar volume of retail sales, which remains below its peak before the recession. 

Robert White of Real Capital Analytics, a commercial real estate consulting and research company, says much of the activity across sectors has been in higher-end properties in primary markets, but the industry is now starting to see more activity in other types of properties and in secondary and tertiary markets. “It’s been a bifurcated market,” he said, “and that's starting to change.”

White forecasts $200 billion in sales volume across sectors by the end of the year and a little more than that next year. “Lots of buyers are interested,” he said, in part because the risk premium is so attractive right now. Cap rates, at 7.9 percent, are particularly attractive in the industrial sector. The biggest drag to more volume is the continuing difficulty investors are having in getting financing.

Kenneth Riggs of Real Estate Research Corp. said the pace of recovery, with the possible exception of multifamily housing, has been measured. That’s actually a good thing, because it's giving prices a chance to improve at a healthy pace. "We're seeing a good rate of growth," he said. "Not too fast."

The analysts said the issue that property owners are having in getting replacement financing for their expiring short-term property debt is still present, but rising prices have eased the problem considerably. Although many owners are still facing hurdles to roll over their debt, the number is far smaller than it's been. 

Source: Robert Freedman, REALTOR® Magazine

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