The economy closed 2012 with positive growth, the slow fourth quarter GDP data notwithstanding. Mirroring that growth, commercial real estate also notched a year of growth and expansion. Fundamentals continued improving through the fourth quarter of the year, with declining vacancies and rising rents. The apartment sector shone brightly, and office and industrial spaces also found favorable conditions. With a strengthening foundation, investment sales found a higher ledge on their climb from the depths of the 2008-09 Great Recession.
With employment in office-centered industries rising, demand for office buildings advanced. For office properties, net absorption totaled 17.4 million square feet in 2012, according to Reis, Inc. The supply of new office space ramped up, but did not match demand—there were about 12.0 million square feet of new completions. Vacancy rates for office properties are expected to hit 16.0 percent by the end of the first quarter of 2013 and to continue declining to an average 15.9 percent for the year. The decline in vacancies is expected to be accompanied by a 2.6 percent rise in rents.
For more information about the 2013 commercial real estate outlook, see the Expectations & Market Realities in Real Estate 2013 report.
Based on early estimates, economic activity closed 2012 on a mixed note. Though gross domestic product grew at 2.2 percent for the whole year, the fourth quarter results were disappointing, showing a 0.1 percent decline. A large 22.2 percent cut in defense spending at the federal level (coming after a surprisingly high defense spending growth in the prior quarter) and a large negative change in private business inventories were key reasons for the mild contraction in the economy.
Commercial REALTOR® markets posted accelerating growth in sales and leasing activity during the fourth quarter of 2012. Based on the results of the January Commercial Real Estate Market Survey, commercial practitioners closed the year on a more upbeat note. Commercial REALTORS® rated business opportunities in the fourth quarter 6.0 percent higher than the previous quarter.
Having recently participated on a panel at the National Apartment Summit, I had a chance to discuss drivers of demand and overall trends for the multifamily market. Investors are still bullish on the performance of the apartment sector, though they are concerned with the pace of job creation and the impact of sluggish economic growth on the under-35 years of age demographic. In addition to low wages, this group of traditional renters has also been contending with increasing education debt levels.
With payroll employment still stuck in second gear, demand for apartments has been slowing into the third and fourth quarters. Net absorption of apartment space—a measure of demand—is projected to be 54.830 units in the third quarter, with a year-end total of 219,318 units. This figure represents a noticeable improvement over last year’s demand numbers, especially in light of the supply trends.
Completions of new multifamily buildings have been rising, boosted by financing availability from Government Sponsored Enterprises. Supply of apartments is projected to total about 31,543 units in the third quarter and 80,000 units for 2012.
Given the strong demand of the past year, there’s still a gap of about 140,000 units between demand and supply of space in 2012. Vacancy rates have been declining, reaching 4.3 percent in the third quarter. However, with the slight decline in demand, national vacancies are expected to close the year at a level 4.3 percent. The local markets with the lowest availability rates are Portland, Minneapolis and New York with vacancy rates of 2.0 percent, 2.2 percent and 2.2 percent, respectively. At the other end of the spectrum, Memphis, Jacksonville and Houston continue to work through rates at or above 7.0 percent. Rent growth for office space has been positive so far and is expected to stay in the 4.0 percent range for 2012, although the underlying fundamentals are pointing to a potential slowdown.
Broader job growth has been slowing through the half point of the year and going into the third quarter. Many companies have also put expansion plans on hold, waiting to see what happens in the national and local economies. Professional and business services have provided a silver lining to the trends, maintaining demand for office space on a positive curve.
Net absorption of office space—a measure of demand—is projected to be 7.6 million square feet in the third quarter, and close the year at 24.1 million square feet. In response, completions of new office buildings have been trailing behind, constrained by the tight lending conditions of the post-recession financial landscape. Supply of office space is likely to total 5.7 million square feet in the third quarter and 13.7 million square feet for 2012.
With a projected gap of 10.3 million square feet between demand and supply of space in 2012, vacancy rates have been declining. Office availability for the third quarter is expected to decline to 16.1 percent. The downward trend is moving national vacancies towards 16.0 percent by the end of the year. The local markets with the lowest availability rates are Washington, D.C., with a vacancy rate of 9.4 percent, New York City, at 10.0 percent, and New Orleans, 12.8 percent. At the other end of the spectrum, Detroit, Phoenix and Las Vegas continue to slog it through rates above 25.0 percent.
Rent growth for office space will stay positive in 2012, although not as robust as predicted earlier, due to the general slowdown in the economy. Rent is expected to rise 2.0 percent for the year, a still-noticeable improvement over last year’s 1.6 percent.