Decline in Commercial Real Estate Sectors Appears to be Slowing

Commercial real estate activity has suffered from a severe credit crunch for commercial sectors, sustained job losses and weak consumer spending, although the decline appears to be slowing.  A forward-looking indicator shows commercial real estate will remain weak into 2010, but recent actions by the Federal Reserve should improve some flow of capital into commercial lending, according to the National Association of Realtors®.

The Commercial Leading Indicator for Brokerage Activity declined 1.3 percent to an index of 101.5 in the second quarter from a downwardly revised reading of 102.8 in the first quarter, and is 13.7 percent below the 117.6 recorded in the second quarter of 2008.  The index is at the lowest level since the first quarter of 1994; NAR’s track of the commercial leading indicator dates back to 1990.

NAR’s chief economist noted the pace of decline moderated, but the leading indicator has fallen sharply and quickly from the peak, suggesting much lower business opportunities for commercial real estate practitioners engaged in leasing, sales and property management.  “The reduction in commercial real estate activity is expected at least through the first quarter of 2010.  Any meaningful recovery is not likely to occur before the second half of next year.”

The decline is driven by falling industrial production, far fewer jobs requiring office and retail space, a fall in durable goods shipments, much lower personal spending, lower retail and wholesale sales, and a negative return on commercial investment.  

“With the economic recession likely coming to an end within six months, a recovery in commercial real estate may soon follow,” Yun said.   “The office sector requires job growth to fuel the demand for additional space, the industrial sector needs a rise in production and the retail sector is tied to consumer spending.  Multifamily housing – the apartment market – often performs in reverse to trends in home sales, but can improve if there is sufficient household growth.”  

The Society of Industrial and Office Realtors®, in its SIOR Commercial Real Estate Index, a separate attitudinal survey of more than 650 local market experts, also suggest a lower level of business activity in upcoming quarters.  Most respondents are seeing sales prices that are lower than replacement costs, and 96 percent report deep rental discounts and increased tenant concessions.

The SIOR index has declined for 10 consecutive quarters and stood at 36.0 in the second quarter, compared with a level of 100 that represents a balanced marketplace.

Realtors® Commercial Alliance Committee chair Robert Toothaker said it is crucial to improve the availability of funds for commercial loans.  “Properties with positive cash flow have had trouble finding financing to roll over debt, transactions are essentially at a standstill and new development is virtually nonexistent in most areas,” he said.

“Commercial loans are mostly short term, and without ready financing even the most experienced commercial players can get into trouble.  The Fed’s recent decision to extend the TALF program for commercial mortgage backed securities beyond the end of 2009 is highly welcome because the flow of liquidity to commercial real estate will be critical for a sustainable economic recovery,” Toothaker said.  “However, unless there is a tremendous short-term recovery in the CRE markets, we expect the Fed will be revisiting the issue of another extension of the TALF program early in 2010.”

Yun projects the unemployment rate to peak around 10.4 percent in the fourth quarter, then gradually improve as 2010 progresses.  “We will need sustained economic growth before many employers have enough confidence to expand the job base and create new demand for space,” he said.

The gross domestic product should contract 2.9 percent in 2009 before growing 1.5 percent next year.  Inflation, as measured by the consumer price index, is forecast to decline 0.5 percent this year before rising 2.0 percent in 2010.

Office Market

The office sector continues to suffer the most from job losses, which reduces the demand for space.  Vacancy rates will probably increase from 15.5 percent in the second quarter to 18.8 percent in the second quarter of 2010.

Annual rent in the office sector is projected to fall 14.1 percent this year and 10.0 percent in 2010 after a 0.4 percent decline last year.  In 57 markets tracked, net absorption of office space, which includes the leasing of new space coming on the market as well as space in existing properties, is estimated to be a negative 75.0 million square feet in 2009 and a negative 47.2 million next year.

Industrial Market  

The contracting global economy has constricted the industrial sector.  Vacancy rates are likely to rise from 13.0 percent in the second quarter of this year to 15.0 percent in the second quarter of 2010.

Annual industrial rent should fall 11.4 percent this year and another 11.7 percent in 2010, after declining 0.8 percent in 2008.  Net absorption of industrial space in 58 markets tracked is seen at a negative 300.0 million square feet this year, and a negative 112.0 million in 2010.  Because much construction in recent years was customized to meet specific industrial needs, many obsolete structures remain on the market.

Retail Market

Given a pattern of weak consumer spending, the retail vacancy rate is forecast to edge up from 11.7 percent in the second quarter to 12.9 percent in the same period of 2010.  Average retail rent is likely to fall 6.1 percent in 2009 and 4.9 percent next year; it declined 2.0 percent in 2008.  Net absorption of retail space in 53 tracked markets is expected to be a negative 25.9 million square feet this year and a negative 3.6 million in 2010.

Multifamily Market

The apartment rental market – multifamily housing – is facing higher home sales by first-time buyers, but also is experiencing increased demand from families who have lost their homes.  Multifamily vacancy rates should slip from 7.4 percent in the second quarter of 2009 to 7.1 percent in the second quarter of next year.

Average rent is projected to decline 1.5 percent this year, then rise 0.8 percent in 2010, following a 2.9 percent gain in 2008.  Multifamily net absorption is forecast at 168,300 units in 59 tracked metro areas in 2009 and 64,600 next year.

The COMMERCIAL REAL ESTATE OUTLOOK is published by the NAR Research Division for the commercial community.  NAR’s Commercial Division, formed in 1990, provides targeted products and services to meet the needs of the commercial market and constituency within NAR.  

The NAR commercial components include commercial members; commercial committees, subcommittees and forums; commercial real estate boards and structures; and the NAR commercial affiliate organizations – CCIM Institute, Institute of Real Estate Management, Realtors® Land Institute, Society of Industrial and Office Realtors®, and Counselors of Real Estate.

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