Slow Improvement in Office; Retail Slides

Fundamentals in most commercial real estate sectors improved or held steady during the second quarter, as per CoStar Group's upcoming national report. But there's always a surprise and the last three months were no exception.

Fundamentals in most commercial real estate sectors improved or held steady during the second quarter, as per CoStar Group’s upcoming national report. But there’s always a surprise and the last three months were no exception.

Improvement is improvement, no matter how slight, and the continued recovery of the commercial real estate market is mainly attributable to one factor: jobs. “The job numbers have been fairly decent and jobs match up with net absorption for real estate because bodies drive the demand for real estate,” Walter Page, director of research for Property and Portfolio Research, CoStar’s analytics and forecasting division, told Commercial Property Executive. “It’s a very, very strong relationship and that’s really what we’re seeing here.”

The numbers tell the story. The national office vacancy rate dropped from 12.9 percent in the first quarter of the year to 12.8 percent in the second quarter. Net absorption was positive at 16 million square feet. “It came in a little bit stronger than we anticipated given the fear of the slowing economy and the European markets,” Page said. “But it was still well within the range of expectations, just a little bit better than we thought it would be.” Additionally, the year-over-year rent growth rate increased approximately 1 percent.  All told, the results are very similar to those seen in the fourth quarter of 2011.

The industrial sector mirrored the office sector for the most part. “It came in just like office; pretty strong and very close to the numbers that were experienced in the fourth quarter of last year,” he noted. The vacancy rate declined two-tenths percent to 9.3 percent and rent growth was 1 percent.  Absorption was also on par with fourth quarter numbers.

What CoStar did not expect in the second quarter was the outcome in the retail sector. “The only surprise this quarter was that retail absorption dropped significantly,” he revealed.  “It was still positive around 3 million square feet, but that’s off from the 15 million-square-foot pace in both the fourth quarter and the first quarter of this year.” Additionally, while the vacancy rate was constant, the 1 percent increase in rental rates was far from what CoStar had anticipated. “We had hoped that at this point we would have seen more momentum in the marketplace for rental rates.” However, the second quarter outcome wasn’t all bad news in retail, as the less than stellar numbers will have a positive impact on industrial, given retailers’ ongoing need for storage space. Quoting a colleague, Page said, “If you want to invest in retail maybe now is a good time to own a warehouse.”

A bright light in the second quarter involves something that is not happening: abundant development activity. Limited new building, according to Page, bodes well for the commercial real estate market regardless of potential negative changes in the economy. “The one thing I can say that’s to the benefit of investors in these sectors is that the low level of construction activity means that even if the job numbers slow, the likelihood is that the vacancy trends will continue to decline because you have very little new construction,” he said. “Nationwide, 65 percent of the office space that’s underway is preleased, which is a pretty high number; normally it’s closer to 40 percent. And we have a lot of build-to-suits so those are all good signs to prevent significant overbuilding–but it’s not to say that people won’t build because when there’s capital available, they will build.”

The commercial real estate outlook for the third quarter is for much of the same. The slow but sure upswing is forecasted to persist. “We expect a bumpy but positive recovery to continue, and as long as we have job numbers that continue to correspond to that, the recovery will be good.”