In Spite of Positive GDP Reading, Caution Still Justified
The reading on total U.S. economic output as measured by Gross Domestic Product (GDP) marked its 10th consecutive positive quarter, reaching 2.8% in the final months of 2011. Coming on the heels of better-than-expected economic readings over the past few months, this is welcome news. Consumption, which comprises 70% of U.S. economic activity, generated a strong gain of 2% in the final quarter of last year. Another positive sign is the reduced reliance on temporary workers by companies as they shifted to more long-term full-time employment during the second half of 2011. At the same time, companies continue to reduce lay-off announcements, sending first-time applications for unemployment benefits down to levels not seen since before the recession.
Commercial real estate investors should take the latest economic reading with due caution for several reasons. While the economy has outperformed expectations and defied a double-dip recession, the pace of growth is unlikely to accelerate further in the short to midterm. In fact, inventory restocking was a major contributor to the fourth-quarter GDP gains and was temporary in nature. Weak government and business spending also point to lower growth rates in the first quarter of 2012. Companies are adding workers at a relatively subdued rate, restraining any significant improvement in the unemployment rate. Macro concerns, escalated recently by Middle East tensions and coupled with the U.S. political log jam, will limit risk taking, keeping growth rates on a steady but unspectacular trend line.
Beyond 2012, the recovery is more likely to break from the drag of macro concerns. Assuming there is continued progress on the European debt challenges, no crisis that sends energy prices skyward, and election-season uncertainty ends, positive forces may begin to bolster growth patterns. Healthy corporate balance sheets and profit levels should spark a more aggressive expansion cycle once the clouds of uncertainty break.
All of this translates to a gradual recovery in commercial property occupancies, at least through the first half of 2012. The supply/demand dynamics for apartments still point to healthy rent growth and near-full occupancy levels in the majority of markets, keeping the sector well ahead in the recovery. Industrial and retail demand have been positive and rising steadily for nearly two years, which is starting to ease vacancy in most metros. The office sector, however, is lagging in net new demand given the chronic excess in space held by most companies as they push for more efficiency. While investors have to pencil in the reality of a painfully slow recovery in most sectors, they should equally weigh the benefit of low interest rates and prospects for above-average rent growth during the back half of a five- to seven-year hold.
Metro selection will also be critical, as many markets that historically faced significant supply-side risks are unlikely to overbuild any time soon. In addition, many of these markets lead the nation in job and population growth rankings. Preferred coastal markets also offer some unique opportunities, with lower-quality properties and value-add investments providing a wider spectrum of yield for those still gun-shy about betting on secondary and especially tertiary markets. The good news is that commercial real estate provides a wide array of investment options throughout the risk/reward spectrum and is standing on the slowly rising tide of an improvement cycle.
Hessam Nadji is senior vice president and managing director of Marcus & Millichap Real Estate Investment Services. He is also the interim managing director of Institutional Property Advisors, Marcus & Millichap’s special division designed to serve the unique needs of institutional and major private multifamily investors. Contact him at firstname.lastname@example.org.
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About Marcus & Millichap
Since 1971, Marcus & Millichap has been the premier provider of commercial real estate investment services. Through the depth of its local market knowledge, the firm has established itself as a leading investment real estate company with more than 1,300 agents throughout the U.S. and Canada. The firm recently formed Institutional Property Advisors (IPA), a brokerage division serving the unique needs of major and private institutional investors.