Economy Hampering Property Fundamentals, Analysts Say

MBA (8/4/2008 ) Murray, Michael
A weak economy is beginning to hamper commercial real estate property fundamentals, based on research and reports from the first half of the year.

“Every major market will suffer slower demand in the near term, and many markets will endure negative net absorption,” said a report from Property & Portfolio Research (PPR), Boston. “Faring the worst will be overheated housing markets, such as Phoenix, Las Vegas and the Florida markets, as well as markets significantly exposed to commercial and investment banking, such as New York and Charlotte. While demand is pulling way back, the near term supply pipeline is still quite full.”

PPR’s report, Weak Economic Conditions Are Troubling For The Commercial Space Markets, said “not surprisingly, vacancies are rising in all four major property types” as strong levels of supply come in this year and demand expectations remain moderate or negative for each property type.

“The combination of these two factors will lead to a swift uptick in vacancies in 2008 [and continuing into 2009 for some property types]," the report said.

In a recent conference call, Raymond Torto, global chief economist at CB Richard Ellis, Los Angeles, said the slowing global economy has impacted commercial real estate fundamentals as net absorption or take up slowed “almost everywhere, and both occupancy and rents have fallen a bit.”

Brett White, president and CEO of CBRE, said the situation will get worse before it gets better.

“Most of you are hoping to hear the fundamentals and commercial real estate have bottomed and business conditions are improving," White said. "I can best describe the current environment as being very challenging and still having a high probability of getting worse before we see improvement.”

“The heightened level of development in 2008 is unsustainable, and given the state of the economy and the floundering capital markets, supply deliveries will recoil considerably in 2009," PPR's report said. "Thanks to relatively short construction timelines, warehouse developers can more quickly switch off the supply faucet, and supply growth for this property type will shut down the fastest, with deliveries expected to fall by nearly 60 percent in 2009. Supply growth will also fall in retail [40 percent], office [20 percent] and apartment [15 percent]."

“It is our view that U.S. policymakers have addressed aggressively and successfully the problems of systematic risk of the U.S. economy," Torto said. "However, we expect more bad news over the next six to nine months from the economy, as job cuts continue, and from real estate markets, as occupancy, rents and prices fall. That said, we think the headlines do not accurately reflect the real estate fundamentals, whether in the United States or across the globe.”

Whether fundamentals were strong or not, CBRE reported its sales for the second quarter in the Americas declined nearly 50 percent year-over-year. Year-to-date sales were down 44 percent. CBRE's sales revenue in EMEA region of the world was down 33 percent, both for the second quarter and year-to-date 2008.

Real Capital Analytics, New York, reported market wide investment sales activity dropped 60 percent during the first half of the year in the United States.

“As expected U.S. capital market activity remained weak in the second quarter. Investor sentiment is extremely cautious, credit availability is sharply limited and buyer and seller expectations are highly polarized,” White said.

"Looking ahead to 2009, apartment, office and retail will all continue to suffer from rising vacancies [albeit at a much slower rate]," the PPR report said. "Demand will remain slow through at least the first half of that year, and supply concerns will linger on, depending on the market. However, the warehouse market will turn itself around rather quickly, with vacancies dropping by 56 basis points in 2009, as the recovery begins."

Despite weaker property fundamentals, White added that when the market conditions do improve, “they should do so with some vigor.”

Globally, Jones Lang LaSalle Hotels, Chicago, reported a 76 percent decline in hotel investment activity from record levels during the same period of 2007. The highest drop was recorded in the Americas, down more than 80 percent, followed by Asia Pacific, falling 67 percent and Europe/Middle East/Africa, down nearly 60 percent. Despite the Americas decline, it remained the most liquid region, accounting for more than $6 billion of transactions during the first half of the year.

While transaction activity significantly declined, the $13.9 billion of hotel investment compares to 2004 when Jones Lang LaSalle recorded $14 billion worth of transactions during the first half of the year, said Arthur de Haast, CEO of Jones Lang LaSalle Hotels Global.

“More importantly, transaction volumes are still significantly higher than those achieved in 2002/2003, which remains the lowest point for the industry in this decade,” de Haast said. “Following the events of September 11, 2001, the Iraq War and the SARS outbreak in 2003, transaction volumes sunk to a low of $3.6 billion in the first half of 2002 and remained weak through the end of 2003. Based on year-to-date numbers, the hotel investment market in 2008 appears to be in a much stronger position relative to the 2002/2003 period.”