Despite the fits and starts and multiple global and domestic headwinds addressed in recent blogs, the economic recovery should continue this year and hopefully gain more momentum as bad news abates. A similar pattern exists for recovery of the nation’s commercial real estate market, only with different lag and lead times by property type.
The apartment market recovery continues to lead. Tenant demand picked up in mid 2009 and gained steam in 2010, resulting in the best absorption levels in over 15 years and well beyond a typical jobs-driven recovery. The vacancy rate fell from 8% as of year-end 2009 to 6.6% as of year-end 2010. Effective rental rates climbed by 2.4% in 2010 and are set to rise by at least 4.5% to 5% with many metros well above the national average.
Apartments have also led the way with investors. The number of apartment sales in 2010 climbed by 32% when measured in terms of number of sales, and by an exceptional 95% when measured in terms of the total dollar volume of sales, albeit from a depressed level in 2009. The average price per unit climbed by 16% (again, from a depressed level in 2009.)
We expect further tightening of the apartment market in 2011 and 2012, with the potential for rent spikes in a number of metros. The current dearth of construction starts indicates that growth in supply will be highly limited through at least mid 2012. From an investment point of view, more buyers are looking at Class B assets and better secondary markets as cap rates for top tier properties in primary have tightened considerably. Apartments in general will continue to be the safest choice for most investors given the supply/demand and interest-rate dynamics and negative psychology regarding home ownership. On the financing side, concerns about the future of Fannie Mae and Freddie Mac cannot be ignored. However, given the strong performance of the agencies’ multifamily portfolio, funding for rental housing is expected to continue.
Unlike in previous recoveries, retail sales this time have lagged economic growth, not led. Total retail sales did not pick up significantly until the second half of 2010, approximately 12 months following positive GDP growth. Since then, sales have been stronger than expected and exceeded pre-recession levels. This is based on core retail sales – excluding auto and gasoline sales – which tend to skew the numbers. Demand for retail space has followed a similar pattern and is now starting to pick up pace. The vacancy rate climbed from 7% in 2007 to 10.5% as of year-end 2009 and stayed there through mid-2010. It has since inched downward to 10.0%. Effective rents are still weak, but beginning to stabilize.
The number of retail-building sales in 2010 climbed by 20% when measured in terms of number of sales, and by 21% when measured in terms of the total dollar volume of sales. The average price per square foot; however, continued to drop by 5% on average.
Recovery in the nation’s industrial market has lagged the economy as a whole. Despite GDP growth of 2.7%, demand for industrial space was basically flat in 2010. As of year-end, the vacancy rate was a high 12.6% and effective rent shrank by 3.7%, on average.
Investor interest in industrial picked up some, although not as much as with apartments or retail. The number of industrial-building sales in 2010 climbed by 14% when measured in terms of number of sales, and by 12% when measured in terms of the total dollar volume. The average price per square foot continued to decline, but by a relatively small amount (1% on average).
Recovery in the nation’s office market has also lagged that of the economy as a whole, due to lackluster growth in office-oriented employment and a large amount of under-utilized space that needed to be reabsorbed. Net absorption of office space finally turned positive in Q4 2010, for the first time in nearly four years. At year-end 2010, the vacancy rate was a high 17.6% and effective rent during the year shrank by 1.7%, on average. However, there were signs of rent stabilization toward the end of the year.
Investor interest in office properties picked up slightly in 2010. The number of office-building sales in 2010 climbed by 8% when measured in terms of number of sales, and by 11% when measured in terms of the total dollar volume. Activity was strongest among Class A assets. The average price per square foot, however, continued to drop, by 9% on average.
The fact that prices failed to climb in 2010 for retail, industrial and office presents investment opportunities at this time. Prices are low – approximately equal to where they were on average – in early 2003. As the economy gathers strength and consumer and business confidence returns, the retail, industrial and office real estate markets should tighten by at least a moderate pace – approximately 0.5 to 1 percentage points per year, enabling rent stabilization in 2011 and rent growth in 2012. In select areas and property types, a faster recovery appears probable. When this is combined with exceptionally low interest rates and a general dearth of construction, this appears to be a unique window of opportunity for the well-qualified investor, particularly for Class B and select Class C investments.
Hessam Nadji is managing director, research and advisory services at Marcus & Millichap Real Estate Investment Services. Contact him at email@example.com.