Washington, DC, May 18, 2006--The expanding economy is pulling commercial real estate along with it, creating strong demand for space. At the same time, institutional investors are returning to the market, according to a commercial market update and forecast presented here at the National Association of Realtors® Midyear Legislative Meetings & Trade Expo.
David Lereah, NAR’s chief economist, said the market fundamentals are improving. “Commercial real estate vacancy rates are falling and rents are rising as the economy expands and jobs are created,” he said. “Growth in the Gross Domestic Product is fairly strong and consumer spending remains healthy. Business spending is on the rebound, and the completion of new commercial buildings has shown positive growth over the last two years.”
Government spending is providing support to the commercial sector, increasing over 2 percent in the first quarter of the year. Strong corporate profits mean businesses are in the position to expand, wages are growing and 2 million jobs have been created in the last year. Imports and exports remain at high levels, fueling port business and industrial activity.
“Unemployment is near a ‘natural’ rate for the U.S. economy, so it doesn’t get a lot better than this in terms of factors that drive the commercial real estate market,” Lereah said.
Several factors could curtail growth: Oil prices are exerting inflationary pressure, interest rates have been rising and construction costs are increasing. “The Consumer Price Index has been trending up over the last two years with relatively higher inflation,” Lereah said. “As a consequence, the Fed has had to raise interest rates to keep inflation in check. Fortunately, it appears the
Fed is near the end of its cycle of raising interest rates.”
Construction costs have been rising faster than the rate of inflation due to global economic expansion. “It really gets down to the law of supply and demand, and right now, construction materials are in high demand in Asian and other overseas markets,” Lereah said.
On the upside, capital is continuing to flow into commercial real estate at strong levels, and delinquencies have fallen. The hospitality sector is the best it’s been since September 11, 2001. With the exception of retail space, new supply is being held in check.
According to the Mortgage Bankers Association, commercial mortgage originations totaled $201.7 billion in 2005, which is a 48.2 percent increase over 2004. Much of the funds, 35.8 percent, flowed into the multifamily sector; this was followed by office real estate, 24.1 percent; retail, 16.5 percent; industrial, 7.4 percent; and hotel, 6.4 percent.
Data from the Federal Reserve shows commercial loan delinquency rates have trended down since peaking around 1.9 percent in 2001 and now are close to 1.0 percent.
Since bottoming-out in the first quarter of 2002, the rate of return on commercial property had trended up and is now in excess of 5 percent, according to Haver Analytics and NCREIF (National Council of Real Estate Investment Fiduciaries). The apartment, industrial, office and retail sectors are converging, with the rate of return varying about 1 percent.
In terms of the overall commercial market, Lereah said migration patterns affect demand. “Migration favors warm weather and low taxes, so states with the biggest net migration are seeing commercial growth,” he said. These include Florida, Arizona, Nevada, Georgia and North Carolina.
NAR projections for five major commercial sectors, including the office, industrial, retail, multifamily and hospitality markets, are based on data provided by Torto Wheaton Research and Real Capital Analytics.
Office vacancy rates are the lowest since 2001, with rent gaining traction in almost every major market. Investment volume in office real estate grew by 34 percent in 2005 to $99.7 billion, and institutional investors have returned to office acquisition.
Approximately
