Investment in commercial real estate in 2007 totaled $427.2 billion – a record-setting level, and a 39.2 percent increase from the previous record of $306.8 billion set in 2006. (Note: this total excludes transactions valued at less than $5 million or investments in the hospitality sector.) But this record-setting pace will not last. NAR projects that the investment dollar volume this year could drop by 30 to 40 percent compared to 2006 levels.
Office Market
Office building transaction volume in 2007 totaled a record $211.0 billion, compared with $133.5 billion for 2006. Equity funds accounted for 40 percent of office investment last year. With the U.S. dollar at historic lows against many foreign currencies, foreign investors were also active, having purchased a record $17.7 billion in office buildings last year.
The level of new supply will be greater this year. Consequently, the office vacancy rate is expected to rise to 13.3 percent in the fourth quarter from 12.5 percent in the last quarter of 2007. Estimates for the first quarter show areas with the lowest office vacancies include New York City; Honolulu; Long Island, N.Y.; and San Francisco, all with vacancy rates of 9.4 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, should total 38.5 million square feet in 2008, down from 57.3 million last year. Annual rent growth in the office sector is forecast at 3.5 percent in 2008, following an 8.0 percent gain last year.
There is a lag factor in the current office market to backfill space by tenants who moved into newly constructed space. At the same time, concerns about the overall economy are causing some tenants to put expansion or relocation plans on hold. These present a challenge to timely and cost-effectively lease space in older office buildings.
Industrial Market
Industrial activity remains strong in port and distribution hubs, with relative weakness around many manufacturing centers. International trade continues to play a pivotal role in industrial real estate. Investment in industrial properties totaled $46 billion in 2007, compared to $38.9 billion in 2006. While institutions and private buyers are responsible for the majority of industrial acquisitions, institutions have actually scaled back their acquisitions for the second year in a row.
Private equity funds increased their appetite for industrial real estate with a number of portfolio deals having occurredlast year. While foreign investors increased their activity in the industrial sector, they only accounted for 5 percent of transaction volume in 2007.
Vacancy rates in the industrial sector will probably average 9.6 percent in the fourth quarter of 2008, up from 9.4 percent in the same period last year. The areas with the lowest industrial vacancies include Los Angeles; San Francisco; Tucson, Ariz.; Salt Lake City; Orange County, Calif.; and Portland, Ore., all with vacancy rates of 6.1 percent or less. Los Angeles is expected to remain a landlord’s market for the next four to five years. Net absorption of industrial space in 58 markets tracked is likely to total 134.7 million square feet in 2008, up from 120.2 million last year. Annual rent growth is projected at 3.3 percent by the fourth quarter, down from 3.6 percent at the end of 2007. Retail Market
Like other commercial sectors, retail experienced a record transaction volume in 2007.
A total of $71.6 billion worth of retail real estate traded hands, up from $46.9 billion in 2006, with 87 percent occurring in the first three quarters of the year. But activity is down year to date in 2008; transaction volume is just $2.2 billion through the first quarter of this year, a year-over-year decrease of 57 percent. REITs accounted for a quarter of retail transaction volume last year.The supply of new retail space is finally being held in check, although secondary markets might be growing because new space often follows population growth. As secondary and tertiary market populations continue to grow, it will become necessary to track those markets in addition to monitoring older retail centers.
Multifamily Market
The apartment rental market – multifamily housing – is attracting risk-averse institutional investors. Of the record $98.6 billion spent in this sector last year, 40 percent of acquisitions were from institutional investors such as pension funds and life insurance companies. Private investors were equally active, accounting for another 40 percent of transactions. This activity is being fueled by otherwise first-time home buyers, who are still "waiting out" the housing downturn before deciding to purchase. In the meantime, they continue to rent, placing downward pressure on multifamily vacancy rates and upward pressure on rents. The number of new multifamily units remains relatively high, due in part to the conversion of condo projects into rental buildings – notably in the Washington, D.C., area and South Florida.
The multifamily vacancy rate should average 4.8 percent in the fourth quarter, down from 5.1 percent in the fourth quarter of 2007. The current national vacancy rate is 4.7 percent, below the 5.0 percent level which is considered landlord’s market. The areas with the lowest apartment vacancies include Northern New Jersey, San Jose, Miami, Salt Lake City and San Diego, all with vacancy rates of 2.9 percent or less. Average rent is projected to rise 5.3 percent in 2008, up from a 3.1 percent increase in 2007.
Down the Road
Despite solid fundamentals, commercial real estate activity so far in 2008 does represent a slowdown from its level in 2007. Many analysts and investors have assumed that capital does not exist and that banks or other sources of equity have put a halt to lending for commercial real estate. This is not the case. The decline in investment activity actually has more to do with a lack of confidence by investors and lenders who are leery about current conditions and (like many potential home buyers) are taking a "wait and see" attitude. More than anything else, the decline in confidence levels is due to investor concerns and reticence about the current and future state of the U.S. economy. Until such time as confidence levels return to normal levels and investors and lenders are willing to take measured levels of risk, investment in commercial real estate in 2008 will most likely remain as much as 40 percent below transaction levels seen last year.
*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. Organizations in the RCA include the CCIM Institute, the Institute of Real Estate Management, the REALTORS® Land Institute, the Society of Industrial and Office REALTORS®, and the Counselors of Real Estate. The RCA also provides commercial products and services. More than 80,000 NAR members offer commercial services, and 60,000 of those are currently members of the RCA.
by Scott MacIntosh
Senior Economist
Commercial/Investment Real Estate
