Grubb-Ellis forecast: ‘Freefall is over, confidence returns’

Grubb & Ellis Company, a leading real estate services and investment firm, released its 2010 Real Estate Forecast, which indicates that 2010 commercial real estate fundamentals will decline more slowly than in 2009, with most property types reaching bottom near the end of the year and beginning a slow recovery starting in 2011.

“The national economy has begun a slow and cautious recovery, but the labor market, which often lags the broader economy, will turn around only gradually with sustained improvement unlikely before the second half of 2010,” said Bob Bach, senior vice president, chief economist of Grubb & Ellis.

Because commercial real estate lags the labor market, it still has a ways to go before reaching its own low point, Bach said in a release Jan. 4.

“The good news is that the freefall we saw in 2009 is over and the future is more certain, giving owners and users of real estate the confidence to begin making decisions again,” he stated.

Commercial Investment

The investment market, which saw transaction volume maintain artificially low levels in 2009 as banks, CMBS servicers and other lenders delayed working through distressed assets, will start to see some of these assets finally come to market in 2010, prompting an increase in sales volume of 20 to 30 percent over 2009 levels. Prices, already down 40 percent from their peak in October 2007, may decline another 10 to 20 percent in order to meet buyers’ expectations.

“Many have called commercial real estate ‘the next shoe to drop,’ but that’s really an exaggeration,” Bach said. “It implies that commercial real estate could wreak damage on the financial system equivalent to the subprime residential mortgage losses, which is highly unlikely because the value of outstanding commercial mortgages is a fraction of the value of outstanding residential mortgages. Nevertheless, losses will mount over the next several years. If banks aren’t lending because they’re coping with losses in their real estate portfolios, this could impede the economic recovery.”

Overall, the fact that banks likely will begin writing off their losses on distressed assets in 2010 means that the capital accumulating on the sidelines will start being deployed, and highly leveraged buildings, many without the capital necessary to attract tenants, will transfer to new ownership, removing what was a major impediment to recovery in the investment market.

Office Vacancy

Nationally, the office market begins 2010 approaching record-high vacancy rates and the most sublease space available since the “dot-bomb” era. According to Grubb & Ellis, a rebound in the office sector is heavily dependent upon employment, and the slow job growth inherent in a sluggish recovery will delay improvement in the office market.

“Early 2010 may see a few isolated months of hiring, but sustained growth in employment is unlikely before the second half of the year,” Bach said. “The fact that the recession has come and gone, however, should provide the certainty necessary for tenants to start making decisions. We may see leasing volume increase in 2010 as a result.”

The national office market’s vacancy rate is expected to reach 18.5 to 19 percent by the end of 2010, the highest on record since Grubb & Ellis began tracking the national market in 1986. Other leasing fundamentals are also expected to continue to deteriorate, albeit at a slower pace before reaching a growth point in 2011. The company expects the market to register an additional 25 million square feet of negative net absorption and rental rates to decline 2 percent in 2010, compared to 62 million square feet of negative net absorption and a 5-percent reduction in rental rates in 2009.

Industrial Market

Despite increases in vacancy and negative net absorption, economic indicators that generate demand for industrial space saw upticks in late 2009. These include global trade, freight shipments, manufacturing activity and even retail sales. This, along with the weakness of the dollar, hints that a recovery in the industrial market could be on the horizon.

Leading market indicators for the industrial sector turned earlier than those for the retail and office markets, Grubb & Ellis reports. The company also notes that the industrial sector is less dependent on job growth than the office, retail and multi housing sectors, which means it could recover earlier, with vacancy rates beginning a gradual recovery in late 2010 and rental rates following in the second half of 2011.

Vacancy in the industrial sector is expected to reach 11.4 percent by the end of 2010, 70 basis points higher than year-end 2009. Landlords will have to weather 75 million square feet of negative net absorption, though that figure represents less than half of the 158 million square feet of negative net absorption in 2009. Warehouse rents will decline 5 percent, an improvement over the 6 percent decline in 2009.

As the manufacturing sector and global trade bounce back, look for port-related industrial markets to lead the recovery – those anchored by either sea ports or inland ports.

Retail Sector

With a significant recovery in job growth unlikely to get underway until later in 2010, Grubb & Ellis expects the national retail vacancy rate to continue to climb, contributing to additional negative net absorption. Recovery in retail will be weak in 2010, but it will begin to generate demand for retail real estate starting in 2011.

“It’s unlikely the shock of the Great Recession will produce a generation of frugal consumers like the Great Depression did, but on the other hand, retail sales will not bounce back to their debt-fueled levels of 2006 and 2007 anytime soon. Retailers and owners of retail real estate will need to adapt to a ‘new normal’ in consumer attitudes that may last for some time, including more conservatism and attention to value as households rebuild their savings,” Bach noted.

Multi Housing

Similar to the other sectors of commercial real estate, job growth is key for a robust recovery in the multi housing arena. The apartment market suffered in 2009 as college graduates had trouble finding jobs and the growing wave of residential foreclosures increased the supply of shadow units – unsold condominiums and houses being offered for rent. Longer term, apartments will benefit from the decline of homeownership rates to pre-bubble levels or less, as well as increased volume of 20- to 29-year-old apartment seekers as the boomers’ kids move out on their own.