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SAN FRANCISCO-The office market will likely continue a down-cycle during the year ahead, with different scenarios for each metro and submarket, according to a forecast by Rreef. The Rreef study, titled “2009 US Real Estate Investment Outlook and Market Perspective,” covers all major commercial real estate property types. It sees the major risk facing the office sector as lack of demand, as opposed to oversupply, pointing out that “The gulf between new supply and demand continues to expand.”

The Rreef study and forecast–prepared Alan Billingsley, head of Americas research, and research analyst Alex Symes, both based in San Francisco–outlines four major themes that will prevail in the office sector over the next year, which it describes as a transition year for the sector. First, investor demand will decline and the general decrease in rent growth will combine to push cap rates higher for office properties. Next, investors will “have little appetite for properties other than core assets” and “Few investors will undertake value-added acquisitions particularly where there is short-term leasing risk.”

The third theme outlined in the outlook is that the flow of capital into speculative new development will cease. Fourth of the four: “As overall market fundamentals continue to decline, and underwriting criteria remain tight, cap rates will increase by 50 or more basis points by the end of the year.”

The Rreef forecast reflects the same concern with job losses that has become a primary topic of discussion regarding the office market and its hopes for recovery. “As office jobs decline by 4 percent during the coming year, all of the top 26 metros will experience negative net absorption, with at least two-thirds losing 1.0 million square feet or more,” the study states.

Development of new office space will continue to decline and will eventually reach “a virtual halt,” which will soften the effects of the reduced demand for space, but some markets will still face challenges because of the new supply. San Jose, Seattle, Miami, Sacramento and Phoenix are among the metros with the highest 2009 supply risk in the near term, but San Jose and Seattle have prospects for resilient demand in the long term, according to the report.

In their discussion of the outlook for rents, the Rreef researchers observe that, “Gone are the days of preserving face rates by adding concessions in many metros.” They forecast that average class A rents will tumble by 10% or more during the next two years, for a total decrease of 15% or more since peaking around mid-2008. Most of this will occur this year, with the sharpest short-term declines generally in markets already suffering from severe imbalances between supply and demand, such as Orange County,Phoenix and Fort Lauderdale.

Although tenant improvement concessions have ballooned, the forecast expects that this trend “should eventually settle down as dwindling rents make higher tenant improvement costs uneconomic to cash flows.” In addition, landlords may also become more selective about the amount of up-front concessions provided to noncredit tenants.

The Rreef outlook anticipates that the office sector will not reach the bottom of the cycle until late 2010, with the national office vacancyexpected to require until 2012 to dip to 14%. The markets with the most favorable prospects, according to the study, include Washington DC, Seattle, San Francisco, Los Angeles, Boston and Portland.

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