Commercial property fundamentals have become an increasingly common discussion topic of late, especially as the residential market continues its slide and prompts observers to worry that despite some reassuring signs, one or more commercial property types may be next in line to take a massive hit.
Add in the ever-present threat of a nationwide recession, and such concerns about the various commercial property markets are far from unfounded, according to panelists who spoke at the recent Mortgage Bankers Association's Commercial Real Estate Finance/Multifamily Housing Convention (MBA CREF) in Orlando, Fla.
From the general standpoint of construction, which is often considered a leading indicator of any individual sector's health, ‘Our sense is that, yes, commercial building is dropping back down,’ stated Robert Murray, vice president of economic affairs at McGraw-Hill Construction. ‘There is no question.’
A tighter credit environment and recognition in many regions that previously high levels of building activity now dictate a need to pull back will affect the rates of development, construction and project completion across multiple sectors. Certain property types in particular, however, pose significantly more cause for anxiety than others.
While Murray pointed to somewhat mixed signals in the retail market, for example, other industry experts view retail as a more definitively troubled area.
During an era when forecasts for other sectors trend toward less drastic worsening, ‘Retail is the one property type that is likely – or possibly – going to look like it did in the early 1990s,’ predicted Bret Wilkerson, chief executive officer of Property & Portfolio Research. ‘All the other property types will come out relatively unscathed. Retail is in a very different place today.’
With construction activity high in 2007 and a great deal of excess space expected, especially in such markets as Houston and California's Inland Empire, vacancy rates will likely rise, while housing-related and other economic pressures will keep consumers away from stores.
Contrary to popular industry belief, however, the specific relationship between home prices and consumer spending is not consistently linear. When houses rise in value, consumers spend more, and when the price increases are especially rapid, consumers spend slightly more, Wilkerson explained. However, when houses' prices fall, consumers do not tend to cut spending until those values have dropped substantially – and then expenditures are curbed dramatically.
Current consumer spending, he added, is in ‘completely uncharted territory.’ Therefore, if a recession does occur, it is anticipated to be strongly consumer-driven rather than business-driven – possibly partially sparing the office sector while battering retail.
Although layoffs and other marks of a business slowdown will likely be felt, corresponding increases in office vacancy rates and widespread sluggish absorption must be evaluated in context, according to Wilkerson. If no recession occurs, office vacancy rates will rise in about two-thirds of surveyed markets, while a recession will trigger a slight jump in vacancy in nearly every surveyed market.
However, ‘That two-percentage-point rise will occur over the next few years, and it will translate to slow – but not massively negative – rent growth,’ he predicted. At the same time, rapidly rising construction costs could help by reining in potentially damaging excess development.
That limiting factor may come too late for Charlotte, N.C., where a currently extremely low office vacancy rate is threatened by the construction of several large-scale projects, noted Murray, who anticipates the city's strong vacancy figure will creep upward within the next two to three years.
{OPENADS=zone=16}Meanwhile, the industrial market, historically seen as a safe bet in the capital markets world, is continuing to show relative resilience. At the same time, no sector can completely escape pervasive economic issues, said Wilkerson, and problems are especially likely to emerge in local industrial markets that are reliant on imports.
Export markets can be expected to fare better, but most exports do not pass through a warehouse while being shipped out of the country – thus somewhat limiting any beneficial effect on the industrial market, he noted.
Finally, according to Wilkerson, the key drivers influencing the property fundamentals in multifamily present another case of conflict between popular industry rumor and reality.
The argument that both prospective and previous homeowners are now likely to become renters in response to the housing downturn is weakened by three specific factors: Housing issues inevitably slow down the entire economy – including the multifamily sector; tough economic times cause a definitive spike in the number of renters who opt to live with roommates; and similarly, Echo Boomers are now increasingly likely to move back in with parents rather than contribute to the rental demand often attributed to that population segment, he said.
Even so, ‘That said, over the next five years, you cannot argue that the demographics aren't there,’ he continued. ‘They're incredibly strong.’
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