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CRE Finance World, Summer 2012

Risks to Recovery in Commercial Real Estate Should we expect deteriorating occupancies and rents for apart- Table 2 ment properties then? Not necessarily. Increased supply growth Sample of Metros with High Proportion of Five-Year Leases is a necessary but not sufficient condition for a severe pullback & Below-Peak Rents in apartment fundamentals. If demand for rentals remains high or rises even further, improvements in occupancies and rent growth can be sustained. Texas markets are betting on benefits from a resurgent energy sector, buoyed by high oil prices. Seattle-based employers like Amazon are continuing to hire more people and lease up new commercial space. As economic growth quickens, a recovering labor market may prop up demand for rentals. Source: Reis, Inc. It is, however, prudent for market participants to examine specific submarkets that may be at greater risk, given this ever-shifting What About Superstar Markets like New York balance of supply and demand. While this kind of supply growth and San Francisco? need not push apartment fundamentals back into recession terri- Even “superstar cities” like New York and San Francisco offer tory, it is important for individual investors to consider how greater cautionary tales. These two metros are at the very top of our competition in specific submarkets caused by the proliferation of rankings for effective rent growth in 2011, with rent levels rising apartment rentals will impact their portfolio’s performance. Reis by 4.8% and 8.6% over the year. New York benefited from its projects that vacancies will hover below 5% for the next few years, usual supply constraint and rising demand for Manhattan CBD but rent growth will peak in 2012. That does not mean rent growth office space; the resurgent tech sector buoyed effective rents for in subsequent years will be negative, but expectations, given the San Francisco office space. absence of tight supply conditions, need to be tempered. However, note how every submarket in Manhattan still have end- Rollover Risk is High for Office Properties in 2012 2011 effective rents hovering at anywhere from 8.7% to 20.7% Office fundamentals have been posting consistent signs of recovery, below peak values attained in 2007, when overall metro rents grew with national vacancies falling by 30 basis points over 2011 to end by over 25%. the year at 17.3%. Vacancies fell by another 10 basis points in the first quarter of 2012, now down to 17.2%. National effective rents Table 3 have also been crawling upwards, rising by 2% in 2011. Manhattan submarkets — percentage difference in end-2007 versus end-2011 rents Unfortunately for the office sector, five-year leases signed in 2007, when rent levels peaked before the recession sent them plunging back down again, are coming due this year. Not all office markets face the same risk. About a quarter of buildings in Reis’s national database of office properties have average lease terms of precisely five years. Some markets, however, have a large proportion of properties with five year lease terms. Combine that with effective rents that are still well below 2007 peaks (despite some improvement in recent quarters), and risk is magnified. Source: Reis, Inc. A publication of Summer issue 2012 sponsored by CRE Finance World Summer 2012 11


CRE Finance World, Summer 2012
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