US Commercial Real Estate Recovery Perseveres

Numerous concerns remain, ranging from last month’s slowdown in hiring to more macro headwinds such as lingering weakness in for-sale housing, Europe’s recession, China’s slowdown, volatility in the Middle East and high energy prices. Further, the pace of GDP growth slowed from 3 percent to 2.2 percent during the first quarter, adding to worries that the economy may be losing momentum.

Despite these impediments, generally strong readings on numerous U.S. economic vital signs counterbalance the negative forces. Record-setting corporate profits bode well for longer-term trends, while lending by banks has started to recover and retail sales maintained momentum through the first quarter.

Private-sector employers hired 2.1 million people over the last year, with nearly every major sector adding jobs. This lays a foundation for recovery in commercial real estate performance, generating steadily improving figures each quarter. In the first quarter of 2012, every major property type registered positive demand trends and falling vacancies. A significant performance gap between property types remains and, despite somewhat tepid momentum in all but the apartment sector, the CRE recovery has clearly broadened.

Apartments once again led the way with vacancies falling 30 basis points in the first quarter to just below 5 percent; rent growth gained further momentum after a strong 2011.  Apartments remain supported by the same seemingly unstoppable forces that propelled their recovery right out of the gate in 2010:  The release of pent up demand with young adults de-bundling from family and roommates to rent their own units, low levels of first-time home buying and low levels of new supply. These positive trends should persist in the short-term, but some clouds may emerge for the mid-term outlook.

The retail and industrial sectors also posted solid momentum so far this year, and are expected to gain further traction as the year progresses. Retail sales remain strong, supporting expansions of new concepts and surviving brands while overall store closures wane. High-profile contractions by Sears, Best Buy and Borders are reflective of the structural changes in consumer shopping and intense competition for capturing sales from a more frugal, value-conscious consumer. Overall, economic growth and corresponding movement of goods throughout the United States coupled with a strong rebound in global trade, drive demand for industrial space. Even the manufacturing sector added jobs at a healthy pace (238,000 in the past year), spurring demand for new facilities.

The laggard remains the office sector, which has been saddled by cautious businesses still focused on cost reductions. Structurally, space consumption per worker continues to decline resulting in lower net absorption. The good news is that tenants’ excess space is burning off and business/professional services is the leading job creation sector. By the third quarter of this year, job growth should translate to a tighter correlation with net absorption and the office recovery should gain considerable momentum over the following 12 to 18 months.

Commercial real estate investors are well served to build plenty of flexibility into both their sentiment and strategy to accommodate for a choppy yet sustainable recovery in fundamentals. The rate of economic expansion may be disappointing, but it remains durable and broad enough to carry the cycle forward. And, assuming none of the head winds erupt into a major shock, the drivers should improve further by 2013.

Source: Globe Street

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