RREEF’s Alan Billingsley

SAN FRANCISCO-Commercial real estate may be recovering from the downturn, but the expression “a rising tide lifts all boats” doesn’t really apply. The effect of a rising tide implies a pretty uniform elevation, and what the industry is seeing instead is different boats in different locations being buoyed at very different speeds. Within the next three or four years, though, we’ll begin to see rent growth across the board, even if that growth proceeds in fits and starts.

It’s among the points Alan Billingsley, San Francisco-based director and head of research for RREEF, made in a presentation late last month at the National Association of Real Estate Investment Trusts’ REITWise conference here. Following the conference, Billingsley charted the sector-by-sector course the recovery will take, in a conversation with GlobeSt.com.

GlobeSt.com: At REITWise, you had projected that several property sectors would start seeing rent growth by 2014. What does it look like for office in the next few years?

Billingsley: Office was clearly impacted the most, and it always takes longest to come back. One thing that’s a little different from the previous downturn is that last time we had a number of companies go bankrupt. That put space immediately onto the sublease market. This time, companies made it through this horrible recession in pretty good shape. We’ve ended up with pretty heavy job losses in the office-using sector, but most companies didn’t downsize their space needs, although the headline vacancy rate doesn’t take into account what we call “shadow vacancy.”

At the end of this year, we expect office to be about 16% vacant, although there’s still extra space out there that companies have to re-occupy before they take out new space. That’s going to delay the recovery a bit more than normal. So, there will be very tepid rent growth this year. But moving into 2013, ’14 and ’15, we’ll start to see stronger growth. Over a five-year period, office will outperform industrial and retail, but remember it’s all back-loaded.

GlobeSt.com: Are there bellwether cities or sectors for rent growth?

Billingsley: There’s a big dispersion on that side. In Washington, DC, rents and occupancy went down, but it was fairly muted and even today it’s pretty strong. New York has really surprised everyone with how quickly it’s bounced back. If you go out to the West Coast, the story is Seattle, San Francisco and San Jose. San Jose has never had a big office market; it’s primarily in the north end of the valley. As the tech markets start to take off, we’re seeing some pretty sharp increases on a small base. San Francisco is also coming back pretty strong; we’re seeing strong leasing activity not from financial services but from tech. Seattle, which was faced with a high vacancy rate downtown because of some high-profile new towers, Microsoft committing to downtown and then un-committing and the loss of Washington Mutual, is coming back nicely as well. The other market of note is Austin, TX, and it follows a theme: another tech-based market. Boston also fits that pattern.

GlobeSt.com: Moving from office into industrial, what do the next few years look like?

Billingsley: Industrial will come back more strongly than office. The vacancy rate will reach historical lows by ’15. However, it’s a tale of two markets. The real vacancy is in the big logistical properties outside the urban areas that really relied heavily on imports for distribution. They will be hurting for awhile. Another problem with those buildings is that they can become obsolete very quickly. What works for Westinghouse may not work for Walmart. What we like is within urban centers—global gateway cities like Los Angeles, where you have entrepreneurs with very strong connections to the home country for bringing things in and exporting things out.

From a matter of historical perspective, every economic recovery I’ve experienced has been primarily consumer-led. That has clearly not been the case this time; it’s being driven by business, which is extraordinary. We’re talking about things like business equipment, software and, of course, exports. This is a part of the economy that benefits industrial.

GlobeSt.com: With the consumer coming back in fits and starts, what’s the outlook for retail?

Billingsley: We’re really mixed on that sector. We believe retail sales are coming back, but it’s low single-digit growth rate compared to the high single-digits that we saw last decade. We’ve moved from the depths of the downturn, where Walmart was capturing an exceptionally high proportion of sales, to people feeling a little more comfortable and going to Target or Bed Bath & Beyond. And the luxury sector is coming back quite strongly. Yet it’s a sector where you really have to be cautious. Sales volume growth is tepid, and a lot of retail centers have vacancy right now, probably due to all of the store closings. While we think most of that is done with, if you’re one of the strong retailers and you’re surrounded by three or four vacant boxes, you’ll probably look to move into one of the higher quality centers. You’re going to see the stronger centers benefit and the weaker centers unravel at a more accelerated pace.

GlobeSt.com: Multifamily growth has been fairly strong. Will that be sustained?

Billingsley: If you go back to 2006 or 2007, apartment rents never really got that high. The sector didn’t peak the way office did, and during the downturn you had institutional-quality apartments lower rents to attract people from class B properties. So it was a tough period. It’s been a surprise to everyone how quickly it has snapped back. You had pretty decent rent growth in 2010, and we expect exceptional growth in the next three years. The downside is that in ’14 or ’15, we’re looking at it easing off—still positive, but we’re already seeing the pipeline of new construction start to gear up. So if you’re looking to buy apartment today and you’re expecting five years of 9% rent growth, it’s probably a little over-optimistic. We’re very enthusiastic about the sector, but we’re having a little difficulty understanding some of the prices being paid.