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Home / Articles / Real Estate / Happy Herald Realty /  Commercial market is on the mend, but not out of danger...
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Friday, June 3,2011

Commercial market is on the mend, but not out of danger...

Until recently, the smart money saw commercial real estate as the next asset class to do a number on the economy. Now some believe it is turning into a feather in the recovery’s cap. But every bet has its risks -- and in this case, better days may be farther into the future than many investors would like. The bullish case for the commercial real estate market is that the bad news is baked in, and what’s left will likely dissipate as the economy gains steam. Wells Fargo sees commercial real estate actually contributing to growth by the second half of this year, driven by more interest in leasing, steadying rents and increasing sales.

Operating fundamentals for all major property types are either improving or showing signs of stabilizing, notes the Wells Fargo Economics Group in its recent economic outlook for 2011 declaring that “the troubled commercial real estate market has turned the corner.”

Meanwhile the National Association of Realtors projects increasing commercial leasing demand and a steadily improving economy “means overall vacancy rates have already peaked or will soon top out. It is anticipating that private sector growth will send investors flocking to apartments, as well as office, retail and industrial spaces. The global real estate company sees investment transaction volume increasing to the tune of $92 billion, which would mark an 80% increase over the low reached in 2009.

Economics is known as a dismal science for a reason: forecasting the economy is inexact at best. But the signs of improvement are pretty widespread and are real. The market is on the mend, but not out of danger by a long shot.

The largest part of the commercial real estate market, the “soft middle,” has barely budged. A greater number of marginal and distressed properties are moving mainly because after sitting on them to see how the economy shakes out, sellers are finally willing to take a hit. It just seems like people have become more reconciled to the world as it is today. It is definitely being more realistic, than optimistic.

One reason it’s hard to start popping champagne corks is the nation’s employment rate. A rough gauge is that each new hire creates about 250 square feet of economic activity. Despite some gains, the nation has not shown enough strength to budge the unemployment rate and many companies are still planning layoffs.

Without an ever-improving economy, two of the most important diviners of a healthy commercial real estate sector, occupancy and rental rates, aren’t going to recover. Currently they are stuck in decline and elevated vacancies are expected to make further rent reductions necessary before a gradual improvement can begin, Add these to the mix — the market’s oxygen, commercial mortgage-backed securities (CMBS), still find few takers; the amount of delinquent CMBS loans $1.4 trillion in bubble-era commercial real estate debt comes due within the next four years.

There will likely be more defaults coming down the pike. The national vacancy rate for commercial properties was 17.5% in the first three months of the year, up from 17.2% in the same period a year ago. It’s ugly out there, but we are not going to see commercial real estate melt down to the point it will need government stimulus like residential real estate. There are pockets of improvement, but those are mostly isolated to higher quality properties in markets such as New York City and Chicago. Small commercial projects, the bread and butter of small and regional banks, need more time before they turn the corner.


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