Commercial RE to See Challenges in ‘08

Beset by a slowing economy and continued fallout from the subprime mortgage crisis, commercial real estate will likely face challenges as demand slows in 2008. Yet factors such as a restrained construction pipeline are likely to prevent a more severe slowdown, according to a report issued Tuesday by ING Clarion on the state of commercial real estate investment. At a press conference on Wednesday in New York on the report, David Lynn, managing director of research and investment strategy for ING, said that, based on the company’s modeling, the recession will be what he termed a “short and shallow one.” The report predicts that the economy could begin to right itself in late 2008 and early 2009, as the housing market finds the bottom and the credit crisis runs its course. Cap rates on all properties should rise by 30 to 60 basis points in 2008, and in this rising cap rate environment, Lynn said there is now a greater focus by owners to manage NOI. He also said in this environment, there is a “flight to quality,” or investors looking for prime properties in prime locations. Cap rates should settle somewhere above their record low of 5.6 percent set in 2007, but Lynn does not believe that they will reach their long-term average of 7.7 percent. The report predicts that the office sector should face demand slowdown, with vacancy rising to over 14 percent this year and in 2009, from the present level of 13.1. Industrial vacancy is forecast to rise from 9.4 percent to its long-term average of 10 percent in 2008 and 2009. But the report said the sector should be helped growing global trade and U.S. exports. The multi-family sector, meanwhile, should be buoyed by the 75 million “echo boomers” in the prime rental years of 19 to 35; tightening lending standards that may put home ownership out of reach for many; and a restrained construction pipeline. But in several markets, such as some Florida cities, multi-family will be challenged by a “shadow rental”market caused by broken condominium projects. The sector could also be challenged by a weakened job market. The worsening job market has also challenged the retail sector. The report said near-term weakness is likely, but demand for retail space should pick up in 2010 and 2011, contingent on healthy economic growth and a rebounding housing market. Of course, the credit crisis has greatly slowed investment in commercial real estate. Stephen Furnary (pictured), ING Clarion’s chairman & CEO, stated that the injection of capital into the large investment banks from such entities as sovereign wealth funds is a positive, as it enables the investment banks to write down their losses, sell their paper and start lending again. ING Clarion’s William Krauch, director of marketing and client relations, said there is still an abundance of capital waiting to be invested in commercial real estate, but many investors are reluctant to invest now, fearing that property they may buy now may fall further in value. “Many want to wait from six to nine months [before they invest],” he said. “That’s when capital flows are going to begin to pick up.”