Living La Vida Local
While the pace of investment has fallen since August/September, first and second quarter activity was brisk. By the end of October, a record $325 billion worth of commercial real estate had traded hands nationwide, with over half involving office properties. As a comparison, $306.8 billion worth of commercial properties traded hands in all of 2006, and $267.6 billion was traded in 2005 – both yearly totals surpassing the $150 billion that traded hands in 2004.

NAR FORECAST: Tighter credit conditions will most likely limit the number of investment transactions. Institutional and foreign investors can only take-up some of the slack and they tend to be primarily interested in properties valued in excess of $5.0 million. Cap rates will slowly begin to rise as prices fall. The era of rapid price escalation may be coming to an end.

The Industrial Market:

Weaker dollar fuels increase in exports, but a noticeable decline in port distribution hub leasing activity …

In recent years the US economy has been importing more that it has been exporting. While this is still true, the weakening US dollar has made US goods more attractive to foreign buyers. While port and distribution markets are still active industrial real estate centers, the vacancy rate in these markets have been edging up slowly in recent months; 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, almost 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.

The areas with the lowest industrial vacancies include 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 144.0 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.

NAR FORECAST: With industrial obsolescence a factor in many markets, many users are considering building or renting in secondary or tertiary markets. In the first ten months of 2007 almost 16% of industrial investment transactions were in markets outside the 57 primary markets tracked in this report. With abundant development land and relatively low concerns with site remediation, these secondary and tertiary markets are poised to generate greater interest by users of industrial space.

The Office Sector:
Investment transactions soar to over $174 billion despite modest up-tick in vacancy….
With jobs still being created in most regions, the demand for office space continues to be positive. The office sector is experiencing new supply, which is for the most part build-to-suit or with a significant pre-lease in place. The problem with new supply is that there is often a lag time for older vacated space to be leased up.  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.Projections for the fourth quarter show areas with the lowest office vacancies include New York City; Honolulu; Tucson, Ariz.; Long Island, N.Y.; Los Angeles; and Riverside, Calif., all with vacancy rates of 10.0 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 total 55.4 million square feet in 2007 and 43.0 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.

Patricia Nooney of Saint Louis, chair of the Realtors® Commercial Alliance, said 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 said.  “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.”

NAR FORECAST: Investment grade office properties with solid income streams will be in most demand by institutional, equity funds and foreign investors. The demand for office space will be positive and new supply will be slowing somewhat. By the end of 2008 the office vacancy rate will be just over 13%, up from the current 12.9%.

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.

The Multi-Family Market:

Hurting  housing market helps the multifamily sector…
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.

The areas with the 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.

NAR FORECAST: Until such time as the recovery in the housing market kicks in and foreclosures start to decline, the multi-family sector will continue to be one of the beneficiaries of these events. Our forecast calls for the year-end vacancy rate for multifamily markets to fall to 5.1%.

The COMMERCIAL REAL ESTATE OUTLOOK is published by the NAR Research Division for the Realtors® Commercial Alliance.  The RCA, formed by NAR in 1999, serves the needs of the commercial market and the commercial constituency within NAR, including commercial members; commercial committees, subcommittees and forums; commercial real estate boards and structures; and NAR affiliate organizations.

The next Commercial Leading Indicator index will be February 20; the next commercial real estate market forecast is scheduled for March 12.