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Realtors: Commercial Real Estate Sectors Basically Strong, Improving

Posted by kinchendavid on November 12, 2006

By Staff, from NAR Press Release

New Orleans, LA  – Commercial real estate sectors are on solid ground with generally tightening vacancy rates and sound fundamentals, according to a commercial market update and forecast presented at a forum on commercial business trends at the National Association of Realtors® 2006 Conference & Expo here.

Lawrence Yun, NAR senior economist, said the expanding economy is pulling up commercial sectors. “Commercial real estate is fundamentally sound with growing jobs and expanding businesses,” he said. “We’re seeing record levels of mergers and acquisitions, and institutional investors have returned in a big way.”

Commercial lending volume is up, and delinquencies are down. High construction costs are holding speculative activity in check, but the value of newly finished construction is running nearly 10 percent above a year ago. Imports and exports remain at high levels, sustaining demand in warehouse and distribution facilities. Corporate profits are strong, providing the wherewithal for businesses to expand. Hotel occupancies have been rising this year and are the highest since 9/11.

“Nearly 4 million new jobs have been created in the past two years, which in turn is creating need for additional commercial space, notably in the office sector,” Yun said. “Wage growth is picking up, household net worth has reached a new high and oil prices have been falling – all providing a nice backdrop for continued expansion in the commercial sector.”

The commercial property rate of return has averaged in the range of 3.5 to 4.0 percent this year, according to the National Council of Real Estate Investment Fiduciaries, with a weaker performance in the retail sector. While the present forecast is positive, potential risk factors for the future include oil prices, interest rates and higher construction costs resulting from global economic expansion; all are being closely monitored for any market impact.

Office Market

With healthy job growth, office market vacancy rates continue to fall in most major markets and are expected to average 13.0 to 12.0 percent in 2007 — a steady downtrend since exceeding 16.0 percent in 2004. After falling in the first part of the decade, average office rents are projected to grow 7.5 to 8.5 percent next year, while new office completions are forecast in the range of 35 to 40 million square feet.

Industrial Market

Trade and distribution continue to drive the industrial real estate market, with a lack of suitable inventory in traditional and inland ports fueling build-to-suit facilities. A low inventory-to-sales ratio, and a low wholesale inventory-to-sales ratio, means there is a need to restock, creating the demand for more space. In addition, orders for durable goods are rising. Some urban industrial properties are being redeveloped for mixed-use and residential purposes.

Vacancy rates in the industrial sector should average 9.7 to 9.0 percent next year, a steady downtrend since early 2004 when they were close to 12 percent. Rents are expected to increase 3.5 to 4.0 percent in 2007, while new industrial space coming online is estimated at 155 million to 160 million square feet and net absorption of space has been trending up all year.

Retail Market

Regional shopping centers have been impacted by vacancies resulting from the merger of Federated and May department stores, and consumer confidence — which has been fairly steady but iffy — is dampening retail leasing. On the upside, personal income is rising and retail sales have been healthy to date.

Retail vacancy rates are likely to rise to an average of 7.8 to 8.2 percent in 2007. After dropping about 1.5 percent this year, average retail rent is forecast to increase 2.5 to 3.0 percent next year, with 20 million to 25 million square feet of new space coming online.

Multifamily Market

The apartment rental market — multifamily housing — is strengthening as potential home buyers remain in rental housing. New supply is matching absorption, keeping vacancy rates fairly flat – next year they are projected to average 5.2 to 5.3 percent. Average rent should rise 4.5 to 5.0 percent in 2007. Between 220,000 and 225,000 new units are likely to come on the market next year.

Not surprisingly, the highest demand is in areas where population growth is greatest. Institutions are very active in acquiring investment grade apartments, and condo conversions have almost completely stopped.

Foreign Investment

Also addressing the commercial forum was James Fetgatter, chief executive of the Association of Foreign Investors in Real Estate. AFIRE’s membership is comprised of about 180 large foreign institutions located in 17 countries, and represents about three-quarters of all foreign investment in the United States. Fetgatter shared findings from an AFIRE survey that evaluated foreign investment in U.S. commercial real estate, examining who’s buying and areas of greater interest to foreign investors.

The survey showed that the mean investment by respondents in the U.S. commercial market was $3.7 billion. “In looking at portfolios held by global commercial real estate investors, by far the most popular region for investment is North America, followed by Western Europe and the United Kingdom,” Fetgatter said. “Smaller investment shares go to Australia, Japan, Eastern Europe and Asia.”

In 2005, $494 million was invested by survey respondents in the United States out of a global total of $801 million; this year the same investors planned to invest $444 million in the United States out of a global share of $943 million.

“Although the United States remains the most popular country for foreign investors, they are diversifying globally and the market share is down this year,” Fetgatter said. “Even so, the U.S. is still favored around the world for or depth and stability, and other sources show the total amount invested this year will be higher than 2005. Most of the investment is from private equity, and foreign investors are now doing more development and also are more active in the second home market.”

The most popular commercial property types for foreign investors are office, hotel, retail, industrial and multifamily. In looking at overall portfolio holdings, 52 percent are in office, 26 percent retail, 12 percent multifamily, 5 percent industrial and 3 percent hotel – the rest are other types.

The most popular cities for global investors are London, Washington, New York City, Paris and Tokyo. Los Angeles was tied for 6th, San Francisco was 8th and San Diego was 10th. This is the first time since 2001 that London surpassed Washington as the most popular investment market. Other U.S. cities receiving favorable rankings include Chicago, Boston, Miami, Seattle, Austin, Phoenix and Orlando.

Thirty-one percent of respondents thought investment opportunities in the United States were much stronger than in other parts of the world, and 34 percent said they were somewhat stronger. Even so, 52 percent said it was very difficult to find attractive investment opportunities in the United States, and 43 percent said it was somewhat difficult. Three-quarters said top competitors in acquiring U.S. properties include domestic pension funds and advisors, and 42 percent identified domestic real estate investment trusts (REITs).

The United States was ranked the most stable and secure real estate investment by 74 percent of respondents, followed by the United Kingdom, 9 percent. The United States also was ranked as the best opportunity for capital appreciation, by 39 percent, followed by China, 12 percent.

The most active foreign buyers in the United States are from Germany, followed by Australia and the Middle East, with the latter two rising in market share and Germany declining.

The AFIRE survey, conducted last year, generated 70 usable responses from 148 major foreign investors, with a response rate of 47.3 percent.

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