Strong Outlook For Commercial Market

staff report

Apr 24, 2006 11:31 AM
Commercial real estate occupancies and capital flows will continue gaining momentum through the end of 2006, according to a recent report commissioned by the National Association of Realtors (NAR). Fueling this broad-based recovery: steady job growth, strong international trade and investors’ ongoing efforts to diversify into commercial property. The analysis crunched data from Real Capital Analytics and Torto-Wheaton Research covering all five core property classes in the top 56 largest metropolitan areas. “Vacancy rates are declining in all of the major commercial sectors, and rents are rising at healthy rates,” says David Lereah, chief economist at trade group NAR, which represents more than 1.2 million chiefly residential brokers. One of the report’s chief findings is that investors poured $268 billion into commercial real estate in 2005, up 44% from the 2004 total on deals above $5 million.

Lereah believes that investors will buy commercial properties as a diversification play. Roughly 13% of all NAR members hold an ownership stake in at least one commercial property.

Office vacancy rates, which closed 2005 at 13.6%, will hit 11% by the end of 2006. This tightening should help office landlords raise rents up by 5% this year. In 2005, by comparison, average rents climbed just 2% to reach $16 per sq. ft. at the end of the year.

Occupancy gains will continue to lead rental growth. The net absorption of office space (defined as the leasing of both new and existing space) this year is projected to register 93.4 million sq. ft., which would exceed the 89.1 million sq. ft. in net absorption posted in 2005. The NAR report did not forecast total investment sales volume, but 2005 saw nearly $100 billion in investment grade office buildings change hands.

Foreign investors aren’t likely to pull back from their acquisition campaigns, either. According to Jones Lang LaSalle, foreign investors spent $21.8 billion on U.S. real estate in 2005. Most of that total was poured into domestic office assets such as Manhattan’s One Park Avenue. Last year, for example, German fund manager SEB Immobilien-Investment GMBH paid $323 million for that property.

For the industrial market, trade with China should continue to bolster traffic and occupancy demand at key ports. Congestion is such an issue at many West Coast ports that some traffic is being re-routed through the Panama Canal. As a result of this activity, industrial vacancy should drop to 8% by the end of 2006 (down from 9.6% at the end of 2005).

Offsetting that vacancy decline, however, new industrial construction will grow 20% this year as new distribution space is built to replace obsolete properties. Rental growth for industrial properties will increase by 3.8% for full-year 2006, which would make for flat rental growth between 2005 and 2006.

Investment sales volume, however, increased a full 65% to $34.5 billion between 2004 and 2005. The hottest markets for industrial space were Chicago, Los Angeles, Atlanta, Dallas and Seattle—and these markets will continue to lure capital and occupancy demand through the end of this year. Despite the addition of new space without sufficient leasing demand, retail vacancy rates should fall slightly through the end of 2006. Retail vacancy closed out 2005 at 8%, but vacancy will dip to 7.8% by the end of December. Net absorption is likely to hit 31.4 million sq. ft. this year, or down from 43.8 million sq. ft. last year. The retail markets that will post the lowest vacancy rates this year include San Francisco, Las Vegas, San Diego, Seattle and West Palm Beach, which will end this year with vacancies of 3.4% or less.