Economic fundamentals, like employment, are inextricably linked to the performance of commercial real estate. As companies shed jobs over the past two years, office markets across the country experienced a surge in vacancies. Emptying buildings led to reduced cash flows, declines in values and increasing distress. However, the rebounding economy may prove beneficial to the foundering office sector.
"It looks like we're at the cusp of nearing stabilization, ' says Kevin Thorpe, chief economist at Cassidy Turley. "But it would be premature and imprudent
to say that commercial real estate has recovered. You really can't say that until, at the very least, the US economy is absorbing more space than it's shedding."
According to Cassidy Turley's Q1 2010 National Office Trends Report,
net absorption registered at negative 3.6 million square feet. Office-using jobs are on the rise, but there will be an average lag time of two to three quarters for positive absorption. Cassidy Turley predicts things will begin looking up around the third quarter of 2010. After that, "the last leg is rent growth, ' Thorpe notes. "We're a ways off as a country before we see office rents rising." His estimation is office rent will remain flat until at least 2012.
In the short term, this won't help with any of the distressed assets currently on the market. "The big problem with distressed assets is you have a high level of vacancy, ' Thorpe points out. "With elevated vacancies, NOIs and pro form as are just shot right now." Help is on the horizon, however, with the US adding 162,000 non-farm payrolls in March, and even with 48,000 of those as temporary census workers, it helps boost office space in the short term.
The question on everyone's mind, however, is: Can this minimal growth slow the steady rate of defaults? "As the economy's gaining momentum, we are
seeing that the number of distressed assets appearing each month is on the decline. According to Real Capital Analytics, $4.8 billion in assets were added to the rolls in March, down from $7.4 billion in February. However, it is important to note that much of that is due to lenders modifying and extending loans, Thorpe reminds, as banks are reluctant to take properties back. So, with a 16.7% vacancy rate nationwide, net effective rents flat at $23.38 and a total of716.7 million square feet on the market with 48 million square feet of new office space due, confidence is still low. "If confidence doesn't improve overall, then that threatens this recovery, ' Thorpe suggests. He believes it's important to focus on the positive momentum and the fact that commercial real estate lags most of these indicators, which, if not growth, show some stabilization of the market. "We need to see some big splash deals, ' he emphasizes. "That's usually the barometer for when the market is truly reaching that inflection point." Thorpe believes opportunistic funds will be the instruments for this turn around, as they turn their eyes from safer game to distress. But, "there's still reluctance on the investors' side. It will take sustained growth before that changes." Not a great outlook, but a good one, for now.
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