CRE Momentum Grew in Q3

LOS ANGELES—Evidence continues to roll in that although the domestic economy still has its share of weaknesses, US commercial real estate is powering ahead. CBRE Group reported Monday that the third quarter saw across-the-board strengthening, with office in particular making its strongest showing in eight years.

“The real estate recovery clearly gained in strength in the third quarter as all property types saw notably improved demand trends,” says Jon Southard, managing director of CBRE's Econometric Advisors group. “Especially important, office tenants showed greater confidence in expanding their footprint and finally appear to be shaking off the lingering effects of the recession.” Q3's office vacancy decline of 40 basis points to 14.1% was the steepest quarterly drop since Q2 2006, while industrial availability declined 20 bps from the previous quarter, as did that of retail.

A report last week from Cassidy Turley also charted the quarterly progress that office made in Q3. The 80 US office markets tracked by the firm absorbed 20.5 million square feet during the quarter, an increase of 20% from Q2 and a 38% rise year over year. Kevin Thorpe, chief economist with Washington, DC-based Cassidy Turley, makes the linkage between stronger employment trends and tightening office supply.    

 “The single most important factor for the office sector is employment,” says Thorpe. “Businesses have been creating well over 200,000 net new jobs per month for several months now, the highest stretch of job creation in almost 15 years. About 30% of those new jobs require office space, so this clearly creates a stronger economic backdrop for the office sector.”

Southard concurs, noting that 2014 is on pace to be the best year for office since the recovery began. “While a low-supply environment has aided the office recovery in the last four years, growing payrolls at office-using firms is now catalyzing strong absorption in some markets,“ he says. “We believe the national office market to be in a 'sweet spot' with declining vacancies as construction remains relatively low and payrolls at office-using firms continuing to grow and reach new peaks.”

Likewise, industrial is maintaining its momentum, although the decreases in availability were smaller during Q3 than in some prior quarters. “The nation's industrial sector continues to impress as the economic expansion has been especially robust in the sectors that affect demand for industrial space,“ Southard says. “We foresee ongoing strength in the industrial market as conditions remain encouraging for further growth.” The sector ended Q3 with an availability of 10.6%.

Although retail was slower out of the starting gate in the recovery, CBRE notes that Q3's retail availability rate of 11.5% was down 70 bps Y-O-Y and now stands 170 bps below the post-recession peak of 13.2%. Lower availability should spur rent growth in coming quarters, according to CBRE.

As occupancy fundamentals continue to improve, so does another metric—pricing. Green Street Advisors said Monday that its Commercial Property Price Index increased by 1% in September. With property appreciation accelerating recently, values in institutional-quality assets are now above 2007 highs in every major property sector.

“Cap rates continue to move lower as investors look for return” says Peter Rothemund, an analyst with Newport Beach, CA-based Green Street. “That trend has legs. Real estate values are higher than they were at the start of the year, but valuations remain favorable when they're compared to the other places investors can put their money in this low-return world.”