Commercial Real Estate Fundamentals Solid

By: NAR: REALTOR® Magazine Online
Rising demand for space is improving commercial real estate markets across the country, according to the latest Commercial Real Estate Outlook, published by the NATIONAL ASSOCIATION OF REALTORS®.

David Lereah, NAR’s chief economist, says the fundamentals are solid. “Vacancy rates are declining in all of the major commercial sectors, and rents are rising at healthy rates,” he says. “Job growth and international trade are fueling demand for space and facilities.”

NAR President Thomas M. Stevens from Vienna, Va., says the flow of funds into commercial real estate is extraordinary. “Investment grade real estate has been changing hands at unprecedented rates, which demonstrates that the value of portfolio diversification into commercial real estate is being embraced strongly in the investment marketplace,” says Stevens, senior vice president of NRT Inc.

Investment in commercial real estate rose 44 percent in 2005 to a record $268 billion of investment grade real estate, not counting transactions valued at less than $5 million.

Many NAR members underscore this wisdom in their own investments: 13 percent hold an ownership interest in at least one commercial structure, and 39 percent own residential properties for investment in addition to their primary residence or vacation home, Stevens says.
The NAR forecast, expanded to five major commercial sectors, includes analysis of year-end data for various tracked metro areas. The sectors include the office, industrial, retail, multifamily and hospitality markets. Metro data were provided by Torto Wheaton Research and Real Capital Analytics.

Office Market

By the end of this year, office vacancy rates are projected to drop to an average of 11.0 percent from 13.6 percent in the fourth quarter of 2005. Office rents are expected to rise 5.0 percent in 2006.

Office vacancies are at the lowest level since 2001. Markets with a wide pool of skilled workers will experience the strongest demand for space in 2006, as will areas with a rapid in-migration of population.

Areas with the lowest office vacancies currently include Ventura County, Calif.; Orange County, Calif.; Riverside, Calif.; New York City; and Miami, all with vacancy rates of 8.5 percent or less.

Net absorption of office space in 56 markets tracked, which includes the leasing of new space coming on the market as well as space in existing properties, is forecast at 93.4 million square feet in 2006, up from 89.1 million last year.

Nearly $100 billion of investment grade office buildings traded hands in 2005. The top suburban office markets for investment are Los Angeles; Northern Virginia; Orange County, Calif.; Dallas; and Northern New Jersey.

Industrial Market

Trade with China continues to stimulate the industrial sector with burgeoning traffic at ports, both traditional and inland. This traffic is causing increased demand for warehouse and distribution facilities, especially for markets near major ports of entry or distribution hubs. Congestion is being reported at major West Coast ports, with some traffic being diverted through the Panama Canal to Florida.

New industrial construction should rise 20 percent this year to accommodate specific distribution requirements and to replace structures that are now obsolete.

Industrial vacancy rates are likely to fall to an average of 8.0 percent in the fourth quarter of 2006 from 9.6 percent in the last quarter of 2005. Industrial rents are expected to grow 3.8 percent this year.

The areas with the lowest industrial vacancies are West Palm Beach, Fla.; Los Angeles; Las Vegas; Riverside, Calif.; and Orange County, Calif., all with vacancy rates of 5.7 percent or less.

Net absorption of industrial space in 54 markets tracked is projected at 270.1 million square feet in 2006, compared with 279.1 million in 2005.

Investment transaction volume increased 65 percent in the industrial sector to $34.5 billion in 2005. The top industrial investment markets are Chicago, Los Angeles, Atlanta, Dallas and Seattle.

Retail Market

The retail sector has undergone significant changes recently with megamergers that will continue to impact markets across the country. This includes mergers of Sears and K-Mart, and May Department Stores with Federated Department stores. In some areas, new space is being built without sufficient demand, but retail space absorption will slightly outpace the amount of new space brought to market this year.

Retail vacancy rates are forecast to decline to an average of 7.8 percent by the end of the year from 8.0 percent in the fourth quarter of 2005, and average rent should rise 4.0 percent in 2006.

Retail markets expected to have the lowest vacancies this year include San Francisco, Las Vegas, San Diego, Seattle and West Palm Beach, which are seen to have year-end vacancies of 3.4 percent or less.

Net absorption of retail space in 54 tracked markets is likely to be 31.4 million square feet in 2006, down from 43.8 million last year.

Investment in retail space increased 16 percent to $46.4 billion in 2005, with strip centers accounting for two-thirds of the total. The top markets for strip center investment include Los Angeles, Phoenix, Houston, Chicago and Atlanta.

Multifamily Market

The apartment rental market – multifamily housing – is tightening, and vacancy rates are forecast to drop to an average of 4.5 percent this year from 5.2 percent in 2005. Average rent is projected to increase 5.3 percent in 2006.

Conversion of apartments into condos accounted for 34 percent of the multifamily properties that traded hands in 2005. NAR expects condo conversion to slow this year, coinciding with an increased demand for rental housing.

Total investment in multifamily property rose 72 percent in 2005 to $86.9 billion, with $29.4 billion spent by condo converters who took 191,400 units out of the active rental market. The top markets for garden apartment investment are Phoenix, Tampa, Orlando, Los Angeles and Atlanta.

Not surprisingly, areas with the lowest apartment vacancies happen to be markets with a lot of conversion activity. These include Fort Lauderdale, West Palm Beach, Miami, San Jose, Calif., and Northern New Jersey, all with vacancy rates of 2.5 percent or less. These areas also are experiencing rapid in-migration, which is increasing housing demand.

Multifamily net absorption is forecast at 289,100 units in 59 tracked metro areas in 2006, compared with 319,400 absorbed last year.

Hospitality Market

The tourism and hospitality sector slumped severely after September 11, 2001, but began to turn around in 2004. With increased occupancies and higher revenues, new hotel construction is now economically feasible.

Hotel occupancies should reach 68.7 percent by the end of 2006, up from 64.5 percent in the last quarter of 2005, and revenue per available room (RevPAR) is likely to grow to $76.01 this year – an increase of 6.3 percent. An additional 31,500 hotel rooms are projected to be added to the inventory in 52 markets tracked this year, up from less than 3,900 in 2005.

Markets with the highest forecast for RevPAR include West Palm Beach, Honolulu, New York City, Miami, Phoenix and Fort Lauderdale, which can see RevPAR in excess of $100.00, far above the national average of $74.39 expected for the first quarter. Areas with the biggest gains in RevPAR, which indicate hot markets for growth, include Honolulu, Houston and Chicago.

Hospitality markets with the highest occupancy levels include West Palm Beach, Honolulu, Fort Lauderdale, Phoenix and Miami, all with occupancy rates of 82.2 percent or higher. For the United States as a whole, occupancy should be 66.1 percent in the first quarter.

The Commercial Real Estate Outlook is published by the NAR's Research Division for the REALTORS® Commercial Alliance (RCA).

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.