Market strong for office space
by Tapan Munroe, as published in the Contra Costa Times’ “Global Village”
Although the sky is not falling, there is little doubt the housing market is cooling off. Will commercial real estate falter as well?
My answer is no, not now.
A critical factor in the current recovery is that the commercial real estate market has been the beneficiary of the recent home building spree. During the housing boom of the past several years, developers used commercial land for housing and kept construction workers busy round the clock with home building, thereby limiting the growth of commercial space.
This was a breathing spell that reduced the oversupply problem and allowed the industry to recover from the bleak years in the period 1998 to 2003.
That depressed commercial property market had resulted from two damaging economic episodes:
- The oil price collapse of 1986 that triggered the commercial space debacle in the oil patch region of Houston-Dallas-Denver.
- The dot-com bust and the tech wreck of 2000-03 that decimated the commercial market in the Bay Area and other high-tech regions of the United States such as Boston and Austin, Texas.
The oil patch and high-tech economies are now doing well, and that is another reason for the improving health of commercial real estate.
The recovery has been encouraging. For nine consecutive quarters, U.S. commercial vacancy rates have declined. According to the real estate research firm Reis Inc., the average vacancy rate in 72 major office markets across the country in the second quarter stood at 13.8 percent compared with 14.2 percent in the first quarter of 2006.
The declining vacancy rate has triggered rent increases of 2 percent for each of the two quarters of this year -- another clear sign of a recovery.
But the national aggregate vacancy rate data do not give us an accurate picture of office market recovery. This should not be a surprise in light of the diversity of the various economic regions of the United States. The economic recovery has been uneven at best.
Job growth is the prime driver of commercial space use. The differences among the various markets reflect the uneven nature of job growth across the country. Another factor in the current resurgence is that smaller companies have created most of the new job growth and this has been a problem for cities that are dominated by major corporations.
Other location-specific factors that have influenced commercial development are business-friendly local governments and local or regional limitations on office space construction
Growing international trade and employment growth in finance, insurance and business services have resulted in strong commercial space growth on the east and the west coasts.
The hottest commercial real estate markets in the nation include Washington, D.C., and its Maryland suburbs, Orange County, New York City, Miami and Phoenix.
Slower improvement in the office market have been in regions hard hit by industrial job losses such as Detroit, Greenville, S.C., Rochester, N.Y., Pittsburgh, Pa., and the Ohio cities of Dayton, Cincinnati and Cleveland.
A nagging question about the viability of commercial real estate in the United States is the impact of rising interest rates. After all, interest rates affect commercial mortgage rates just as they affect home mortgage rates.
The key difference between residential and commercial mortgages is that in the former case buyers are mostly private individuals who are sensitive to rate changes compared with the latter, where investors are a diverse group that includes institutions such as pension funds that can pay cash and not borrow money, according to Glenn Mueller of Dividend Capital Group in Denver.
Another factor underlying the surge in commercial real estate is that there has been strong international demand for U.S. commercial properties. Australia and Germany are the leaders in the foreign stampede to acquire American properties.
Why? There are four reasons:
- The declining value of the U.S. dollar relative to the Australian dollar and the euro that makes U.S. properties more affordable.
- The pull of the No. 1 economy in the world, the United States.
- Flight to safety: lower political and economic risks in the United States than in Europe and Asia.
- Fair laws and highly developed U.S. financial markets attract institutional investors such as pension funds from Australia and Europe.
So far, the recovery of the commercial real estate industry has been promising and near-term prospects are good. However, this is also a cyclical industry and its future depends on the state of the U.S. economy (particularly job growth) in the coming year and beyond.
About the Author
*This article appeared in the Contra Costa Times on Sunday, December 18th. Tapan Munroe, an economist and longtime resident of Contra Costa County, is a director of LECG LLC, a worldwide financial and economic consulting firm with headquarters in Emeryville. His column runs every other Sunday. Opinions expressed here reflect his viewpoint only. He can be reached at tapan@tapanmunroe.com.
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