I received this article via email, from a Wells Fargo representative, I thought to share these positive news with our visitors.
Monica Barrow
Broker Owner
Special Commentary
Economics Group ,March 13,2014
Commercial Real Estate
“Commercial construction is finally beginning to improve”!!.
Commercial real estate fundamentals have improved to the point that commercial construction is finally beginning to improve. Demand for office, industrial and retail space has steadily improved over the past couple of years and, with very little new construction, vacancy rates have fallen across the vast majority of markets. The greatest improvement continues to be in metro areas with exposure to the energy and technology sectors. The proportion of markets seeing improving conditions has broadened, however, and new construction is ramping up across an increasing number of markets.
The apartment market has followed an entirely different recovery path. Rental apartments are accounting for a disproportionate share of new housing. Demand has outpaced supply for the past 15 quarters, helping drive vacancy rates down to just 4.1 percent. Even here, however, metro areas tied to the booming energy and technology sectors have recovered ahead of most other areas.
Office vacancy rates have fallen less dramatically but have been gradually trending lower. The national office vacancy rate ended the year at 16.9 percent, as 28.5 million square feet were absorbed over the course of the year. Vacancy rates declined in roughly two-thirds of the nation’s metro areas, with the largest declines occurring in major technology centers such as San Jose,
Boston, Austin, San Francisco and Seattle. Technology is playing a larger role in other markets, however, accounting for an increased proportion of office-related employment growth in areas like Atlanta, Dallas and Los Angeles. Office construction more than doubled in 2013 and should post a larger gain this year. Work has begun on several large office projects, including skyline altering and a new tower for BHP Billiton Tower and new office complex for Exxon in Houston.
Commercial Real Estate Vacancy Rates Percent
Office Vacancy Rate: Q4 @ 16.9%
Industrial Vacancy Rate: Q4 @ 7.6%
Retail Vacancy Rate: Q4 @ 10.4%
Apartment Vacancy Rate: Q4 @ 4.1
While the recovery in office development is still in its early stages a few trends are emerging. Newer areas of the tech sector, including social media, cloud computing, big data, health management software, payments processing and internet security are the driving influence behind much of the growth in office demand around the country, both in established tech centers and many other markets around the country. Atlanta, which has a relatively small tech sector, has derived a disproportionate share of its growth from the tech sector, which has helped propel job growth up at its strongest annual pace in 7 years and pulled vacancy rates down so that new office development is beginning to move forward. Of course, the greatest concentration of projects is in Silicon Valley, where Apple, Facebook and Samsung all have major projects underway.
Not only are tech projects leading the recovery in office demand but many of the new buildings being development are incorporating many of the technology-savvy features and layouts that were originated at some of the nation’s most innovative companies. This is particularly true of new downtown office towers and new building sprouting up near mass transit nodes by major urban centers. While this trend is most evident in major tech centers like San Francisco and Seattle, significant towers are either currently under construction or have recently been announced in Houston, Los Angeles and Philadelphia. Houston is one the most active office markets in the Several buildings have been announced recently, including a 47-story spec tower being built by Hines and a 30-story office project announced by Crescent.
The apartment market has seen the strongest recovery of any major property-type benefiting from both the rebound in employment growth and decline in homeownership. Most of the growth in households since the recession has ended has gone toward rental housing. Demand for apartments has been strongest in areas where job growth has risen the fastest, which once again
tends to be concentrated in major technology and energy sectors. Demand has improved much more broadly, however, and a surprisingly large proportion of new construction has occurred in and around downtown areas.
The rebound in apartment development has gone on long enough that a few markets, including Washington D.C. and Boston, are now beginning to worry about oversupply. With vacancy rates at cycle lows nationwide, fears about overbuilding, for the most part, appear to be premature.
There is a great deal of construction in the pipeline and rent increases, which had been running well ahead of inflation and wage growth, have recently moderated. Job and income growth are accelerating, however, and demand is likely to remain strong in coming quarters.
Demand for industrial space has been another bright spot, benefitting from the explosive growth in online retailing, growth in international trade, the revival in domestic manufacturing activity and emerging recovery in single-family home building. Overall vacancy rates declined 0.8 percent points this past year, as about 125 million square feet of space were absorbed. The sharpest increases in net absorption occurred in the Inland Empire of California, Dallas and Atlanta.
Nonresidential Construction Spending
The recovery in construction spending has been sluggish with the real total value of nonresidential construction down 1.5 percent in 2013 to $561.9 billion. Improvement in private construction spending has been fueled by the commercial sector which has seen solid gains in hotel, office and retail, while public and institutional outlays remain weak. Rising building and labor costs remain an impediment to a stronger recovery. According to the Engineering News Record Cost Index, construction costs increased at more than a 5 percent annual pace in the fourth quarter. Much of the increase in costs is due to a surge in skilled labor, but building costs are also up.
Commercial/ multifamily debt outstanding rose one percent in the third quarter, to roughly $2.5 trillion. Commercial mortgage debt reached its highest level since 2010 and continues to be led by banks and thrifts and life insurance companies. Life insurance companies, which make up almost 18 percent of total commercial debt, has seen solid growth over the last two years, while CMBS is still recovering. Multifamily mortgage debt rose 1.2 percent and is up nearly 5 percent over last year. According to the most recent data from the Senior Loan Officer Opinion Survey, lending conditions for commercial real estate loans continued to ease as demand also strengthened.
Operating fundamentals for commercial real estate continued to improve, with the apartment sector leading the way. Apartment demand remains robust with the national vacancy rate falling 50 basis points over the past year to 4.1 percent. Low vacancy rates have assuaged fears about overbuilding. Supply in the apartment sector is ramping up, however, and will likely outpace demand in 2014. Cap rates across the four major property types trended lower in the fourth quarter. Much of this compression remains in the apartment sector. Investors seeking a bit more yield are showing greater appetite for other property types than low-yielding major metro areas that have seen more transaction volume. Source: Reis, Inc., PPR, RCA Analytics, NCRIEF, IHS Global Insight, Commercial Mortgage Alert and Wells Fargo Securities, LLC’
Apartment fundamentals continue to outperform all major property types with the sector absorbing nearly 165,000 units in 2013. Although demand has moderated from its peak in 2010, stronger job growth should keep absorption strong. Rent growth rose 3.2 percent in 2013, which is a touch slower than the 3.9 percent increase in 2012. Developers ramped up construction activity. Completions jumped by 127,000 units, which is the highest annual total since 2009. The increase in apartment development has raised some eyebrows in this otherwise sluggish recovery. The rush to complete properties does have a boom feel to it in certain markets. Source: Reis, Inc., RCA Analytics, IHS Global Insight.
Office fundamentals have slowly but steadily improved over the last three years. At 16.9 percent, the office vacancy rate is still more than 400 bps above its pre-recession low. Net absorption is still well below its cycle peak and is not expected to gain much ground over the next couple of years. With demand stuck in slow gear, new construction has been limited and is only expected to constitute 0.8 percent of total stock in 2013, which is well below the long run average of 1.8 percent. Office employment has outpaced overall job growth and is at its prerecession peak. The mix has shifted toward more creative users, boosting demand for urban locations.
Retail space has been slow to gain any meaningful traction in this recovery and has lagged the other key property types. The retail vacancy rate peaked more than two years ago at 11.1 percent, but has barely budged in recent quarters. The vacancy rate now sits at an elevated 10.4 percent in the fourth quarter. Weak consumer fundamentals and competition from online retailers continue to weigh on the sector. Net absorption remains substantially below its pre-recession peak. Demand should strengthen as the economy gains momentum and home construction improves. After bottoming in mid-2011, effective rent has risen for nine quarters, climbing nearly 2 percent.
Warehouse fundamentals continued to improve in 2013 with demand surging to its highest level since early 2008 in the fourth quarter. The spike in demand helped pull the vacancy rate down to 7.6 percent. E-commerce continues to be a key driver of demand, as many online retailers grow their distribution network. Net completions remained fairly muted in 2013; however, the pipeline is growing. According to amount over last year and with the quick turnaround in building industrial space-roughly six months-the supply picture can change fairly quickly. Construction underway as a percent of stock remains well below the long-run average.
March 13, 2014 ECONOMICS GROUP
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