Real Estate Column

Have we hit bottom in commercial real estate?

  • Article by: DON JACOBSON
  • Special to the Star Tribune
  • March 24, 2011 - 1:44 PM

"Stability" is a relative term. In today's commercial real estate world, it means something different than it did, say, five years ago, when offices and shopping malls were full, construction cranes were in the air and banks were lending.

Nowadays it means "finding a bottom." And as the battered real estate markets head into 2011, the consensus among experts is that next year will bring a measure of stability in the form of a bottoming out of the two-year slide in the industry's key fundamentals, such as rents and vacancies.

As 2010 draws to a close, a steadily improving economy is producing higher demand and some long-sought stability for at least three of the four legs of the commercial real estate industry: industrial, retail and multifamily housing. But the biggest sector -- office -- is more complex, with things quickly improving for the very top and bottom parts of that market but more trouble ahead for the vast middle.

Bank financing is likely to remain hard to come by next year for all but the most "slam dunk" properties, but equity capital is returning to commercial real estate, the experts say.

Typical among the forecasters is Lawrence Yun, chief economist of the National Association of Realtors (NAR). Speaking in Washington last week, Yun said commercial real estate markets are flattening out, with modestly improving fundamentals expected in 2011.

Thanks to an improving economy, he predicted leasing demand will go up and said the seemingly never-ending rise in vacancy rates has "already peaked or will soon top out. The outlook for the office and industrial markets has moderated with modestly declining vacancy rates expected as 2011 progresses, while the retail sector should hold fairly steady."

The rents that office landlords can expect to charge, however, will continue to go south next year, Yun predicted, which won't help the vast majority of them who have less-than "investment grade" properties and are struggling to hang on. U.S. office rents are expected to decline 1.6 percent in 2011 despite a return to "positive absorption," wherein more office space is being leased than coming vacant.

If this definition of stability doesn't seem like much to celebrate, that's an indication of the "new normal" in the industry, said Ken Riggs, chief economist of the Chicago-based CCIM Institute, the group that certifies commercial real estate professionals.

"I would say, very carefully, that the commercial real estate markets in a broad basis are starting to stabilize," he said. "We do see, I think, a very positive sign in that there is now capital to invest in the market."

But any assessment of the market as "improving" or "stabilizing" has to be tempered with an understanding of the relativity of those terms, he said.

"I would just caution that there's a long way to go. This is going to be a long, drawn-out economic recovery, it's going to be a long, drawn-out commercial real estate recovery, where there's going to be fits and starts and it's going to be very uneven," Riggs said. "The coastal areas will do much better and in the places in between -- like Chicago, like Minneapolis -- it's going to be a slow process."

This will be especially true in the office market, which he sees as "trifurcated." The top third of highly desirable Class A properties and the bottom third of distressed and repossessed buildings have been "re-priced" in a way that makes sense for investors to move in and "clear the market" of excess inventory. But that hasn't happened yet with the other third.

"There's a lot that's stuck in the middle," he said. "It's kind of like the residential housing market in that respect. You just don't know what's going on."

Local experts are echoing the findings of the NAR and the CCIM Institute in their own prognostications for 2011. St. Louis Park-based Grubb & Ellis/Northco Real Estate Services, for instance, released its year-ahead outlook last week and similarly concluded that stability is returning to the industry -- albeit with big caveats.

The biggest one is for the Minneapolis-St. Paul office market, where little relief in terms of vacancies and sliding rents is forecast, partly because of vast amounts of space available for sublease.

But the industrial sector and even the much-maligned retail segment -- which are finely attuned to any improvements in the state economy -- are poised for rebounds, the firm predicted.

A "plethora" of industrial tenants seeking big spaces came into the market late this year, and retail space in such strong submarkets as Maple Grove, Woodbury, Bloomington and Roseville will see more takers in 2011, said Grubb & Ellis/Northco Vice President Matt Boehlke.

"We're also seeing a rebound in investment sales of top properties, which I think is creating momentum for the rest of the commercial real estate markets," he said, citing last month's sale of the 29-story 50 South Sixth building in downtown Minneapolis to Hines Global REIT for $180 million.

"That building was able to sell at a fair price, and now you're starting to see other properties being put on the market," he said. "Last year, building owners were afraid to even test the market because they knew they wouldn't get what they were looking for.

"When these sales pick up, you start seeing more optimism in the broader market in general."

Don Jacobson is a St. Paul-based freelance writer.

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