ENCINO, CA-We’re by no means out of the woods, and risks remain, but the US office and industrial markets are likely to continue improving. That was one of the conclusions that could be drawn from a Marcus & Millichap webinar Tuesday that provided a mid-year review and forecast of those markets.
The webinar, listened to by 2,000 investors nationwide, provided a wide-ranging and in-depth look at how the office and industrial markets are performing, the economic forces affecting those markets, and the capital markets environment. Along with commentary from Marcus & Millichap execs Hessam Nadji, William Hughes and Alan Pontius, the event included a host of detailed slides of graphs and charts providing statistical analyses of the economy, cap rates, investment activity and other factors driving the markets. Nadji is managing director of research and advisory services at Marcus & Millichap; Hughes is managing director of Marcus & Millichap Capital Corp.; and Pontius is managing director of the company’s National Office and Industrial Properties Group.
The full title of Tuesday’s webinar was “Special Mid-Year Office and Industrial Market Outlook: Soft Patch or Recession?” The last part of the title raises the question of whether the US is in an economic soft patch or a recession and what that might imply for commercial real estate markets. As he did in two other previous webinars on the apartment and retail markets, Nadji concluded that what we’re in now is a soft patch, not a recession, but he cited headwinds and other factors that present risks of a downturn.
“Our assessment, plus that of others, is that we are in a soft patch with a lot of serious concerns,” Nadji said. But if those concerns wane, we should get to 2% to 2.5% growth in GDP, and later in the year, pent-up corporate demand could push the growth to 4% or over for a while, he said.
A chief concern for the office market is jobs. As disappointing as the job picture is, Nadji said, the US has added 1.7 million private sector jobs, and one of the biggest gainers has been the category of professional and business services, which bodes well for the office market. However, job growth has yet to contribute significantly to reducing office vacancies because businesses still had excess space to burn through when the recovery began. Nadji pointed out that local and state governments have actually been a drag on the employment picture because they have cut jobs.
“We expect the next few months to be slow, and after that, if we get past the debt ceiling and sovereign debt issues, we should get to 150,000 to 200,000 new jobs per month,” he said.
Other headwinds that Nadji listed included energy prices and the single-family housing market. “When energy prices go up, they either cause recessions or make them worse,” he said. The single-family housing market is in a double dip, and is therefore a hindrance rather than a help to the recovery, he said.
Pontius, in his review of the office and industrial markets, pointed out that the rising prices and declining cap rates being paid for some office and industrial properties have led to “debates about whether the market is rational or irrational.”
On one side of the debate, Pontius explained, people ask, “Has the market already forgotten? Is memory that short? Here it is 2011, and there are examples of transactions occurring at cap rates as low as or lower than the low points of 2006-2007. How can that possibly be?”
On the other side of the debate, he said, the counterpoint to the observation about low cap rates is, “We continue to have a favorable spread between cap rates and interest rates, the primary markets are coming back and the supply side of the equation has not been problematic.” Said Pontius, “There are reasonable arguments on both sides of the question.”
Among other points, Pontius outlined the differences between dollar volume and transaction count in investment sales. “You may hear that the marketplace has exploded, and volumes are double and triple what they were a year ago,” he said. “When you hear that, people are talking about dollar volume. My personal opinion is that transaction counts are a better expression of how active a market actually is.”
The trend line for transaction counts is definitely positive, Pontius said, although the transactional velocity growth is actually trailing Marcus & Millichap’s expectations, both for office and for industrial deals.
Pontius also touched on a number of other facets of both the office and industrial markets, including comparisons of fundamentals against investment activity, a number of different metrics including the spreads between cap rates and interest rates, and factors such as continued growth in port activity, which is driving industrial demand.
Hughes, noting that the capital markets “performed well the past six months,” said that the general outlook going forward is positive. “Obviously, rates have been a boon to the commercial real estate market,” he said. The spreads between cap rates and interest rates are currently about 540 basis points in office and 550 in industrial, he said, “which bodes well for positive leverage,” Hughes said.
Pointing out that lenders’ attitudes have stabilized over the first half of this year, Hughes said that deals are being done primarily in larger markets for properties ranging from best-of-class to B quality. “Lenders, as you might expect, are looking for a good quality and consistency of revenue stream,” he said. He cited debt yields of 9% to 11% and loan-to-value ratios of 60% to 75%, although capital markets sources are limited for lower-quality product and smaller markets. Commercial banks, CMBS lenders, life insurance companies and finance companies are all involved in the capital stack, he said, although he pointed out that CMBS issusance this year is likely to fall short of forecasts. He estimated CMBS will total $32 billion to $35 billion for this year, compared with forecasts of $50 billion. About $12 billion of CMBS is in the pipeline now, he noted.