Will Southeast's Upturn Turn South?

The economy was slowly beginning to recover from a shallow recession in third quarter of 2001. The World Trade Center terrorist attack then drove the economy back down. It is now also official that we had a three-quarters-long recession. All of this had a serious negative impact on real estate, given the resulting loss of jobs and the low rate of capital investments.

The hotel segment today remains the most affected market segment. On the other hand, hotels should be the first to recover, and at least one REIT is buying into this sector. Multifamily and retail are seeing increasing vacancies. Some new construction continues but is declining in general. Growth markets are faring better due to continued population growth. The multifamily, retail, and hotel markets should be in the recovery mode by early next year.

Office and flex properties are still weak. The massive failures in telecom and the dot-com meltdown have sharply reduced demand and increased supply. There is only limited development. Concessions and reduced rents are widespread. Available sublease space overhangs the markets, many of which are flirting with 20% vacancies. Medical office buildings are the most robust of all real estate market sectors, where we see substantial development underway and good occupancy and rents. Defense and financial services are also driving some office and flex absorption.

Geographically, the Atlanta, Nashville, Miami, West Palm Beach and Raleigh-Durham office markets are improving. These are followed by Tampa and Memphis. Washington, DC and New Orleans remain weak for now. Orlando is seeing some renewed interest by call centers. By early next year, the office market in general will be at the beginning of its recovery phase. Not surprisingly, technology and telecom-rich markets will be among the last to recover. Washington, DC; Richmond; Birmingham; Memphis; and New Orleans should lead the way.

The industrial market remains in recession in the Southeast. Vacancies are in the 10%-to-12% range, the highest since 1982. Construction completions are down sharply. Warehouse and distribution markets are reasonably stable, but rents will be down to flat for the rest of this year. West Palm Beach and Orlando should be among the first to recover with New Orleans, Jacksonville, Miami, and Nashville also leading the way. They would soon be followed by Atlanta, Charlotte, Ft. Lauderdale, Jacksonville, Miami, Nashville and Tampa.

In terms of building, construction has slowed across all sectors. Capital remains available, but more equity is required since lenders are looking carefully at market conditions before lending. Tenant retention is a key goal for owners. Large public users such as Ford, Lowe’s and Wal-Mart continue to implement their plans for new distribution space. Local and regional companies are buyers in most markets.

Consolidation of space by users is a trend that continues. Low interest rates have cushioned the impact of higher vacancies and lower rent rates. As a result, there have been few mortgage defaults. The demand for investment purchases exceeds the supply of available properties. As a result, sellers are achieving very low cap rates and buyers have to compete for buildings.

On the other hand, building owners have to compete for the tenants that are in the market. Many clients, especially national companies, are taking short lease extensions or deferring expansion or relocation decisions. This is due largely to that fact that operating expenses will rise sharply due to increased insurance and security costs. Since terrorist insurance is hard to procure and costly, refinancing and acquisitions are more difficult, and no immediate fix is in sight.

Barring another significant terrorist incident, the real estate market is poised for improvement. If an incident occurs, there will be a negative impact for two or three quarters. (Note: Sources included Legg Mason Equity Research, NAI, CB Richard Ellis.)

Think Tank member George D. Livingston is president of Realvest Partners and a general partner of many industrial and residential developments. He has served as chairman of the Orange County (Florida) Planning and Zoning Commission.