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CRE Finance World, Winter 2012

CRE Fundamentals and Slow Economic Growth Will slow economic growth over the next few years derail Victor Calanog Faruk Ozdemir Head of Economics & Research Associate Director for Research the nascent recovery of various sectors? Reis, Inc. Reis, Inc. F annualized third quarter GDP growth came in at 2%, to boost office leasing activity.to come down, they remain at levels unseen since the early 1990s.Much like how anemic job growth is unable to push the unemploymentrate down, economic growth isn’t coming in at a fast enough paceears of a possible double-dip recession roiled financialmarkets from May through November, fueled by sloweconomic growth and political paralysis in the US andEurope. Although those fears abated somewhat after the consensus remains that growth will remain slow in upcoming Figure 1 quarters. If the consensus is correct, how will commercial real estate Office Net Absorption and Vacancy fundamentals fare in an environment of slow economic growth? If GDP growth in 2012 is less than or about 2%, it is likely that commercial real estate performance will mirror 2011. Rents and occupancies will improve at a relatively slow pace, although each property type will recover at vastly diverging rates, given the structure of the last recession. As such, we will detail our outlook by property type. Office Properties Mirror the Labor Markets The recent shift to negative sentiment in the market and fear of economic slowdown has the potential to undermine the nascent recovery in the office sector. The key issue is whether employers ratchet down their plans to hire new workers over the coming year or two because of heightened uncertainty; if hiring plans slow, then leasing activity will also slow. Consider how office buildings around the nation performed through the third quarter. Office properties have posted gains in net absorption since the fourth quarter of 2010, following eleven consecutive quarters of decreases. In 1Q11, net absorption was roughly 6 million square feet, up from 4 million sf in 2Q11 and 5.9 million sf in 1Q11. Still, a 15.9 million sf increase in occupied stock is very modest, given that the US office sector has absorbed that much space in a single quarter during healthier times. Source: Reis, Inc. While quarterly trends argue for a recovery that is gaining speed, What about rents? Asking and effective rents have also increased monthly data suggests the opposite: a slowdown in leasing activity fairly consistently over the last four quarters, albeit at less-than- that is largely reflective of the disruptions in the economy in the spectacular rates. Asking and effective rent increases of 0.4% second and third quarters. Net absorption in September was and 0.6% respectively, in 3Q11 are virtually on par with the rent roughly 1 million square feet, down from 2.1 million square feet increases observed during 1Q11, when it appeared that both the in August and 3 million square feet in July. employment situation and the economy were gaining momentum. There are certainly some positive trends, including increasing supply The ongoing increases in asking rent suggests that despite the growth. In one of the more hopeful signs for the market, despite economy’s struggles in 2011, landlords remain confident enough the economy hitting a rough patch and still tight credit conditions, about their prospects to move beyond adjusting concessions and some 3 million sf of office space came online in 3Q11. The net continue to increase face-level asking rent. Effective rents kept absorption of 6 million sf led to a 10 bps decline in the vacancy pace with asking rents for the fifth consecutive quarter, indicating rate from 17.5% to 17.4%. While vacancies are slowly beginning that landlords have likely stopped increasing concession packages. CRE Finance World Winter 2012 24


CRE Finance World, Winter 2012
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