Scotsman Guide - February 2011 Commercial Edition

Property TypeCast
By Victor Calanog
DIRECTOR OF RESEARCH, REIS INC.
DOWNTOWN OFFICE MARKETS TRUMP SUBURBS
In a distinct reversal of fortune, office buildings in central business districts (CBDs) are per-
forming better than their suburban-market counterparts. This is in stark contrast to the mid- to
late-1990s, when suburban office space was expected to be one of the best-performing asset
classes in commercial real estate.
Overall, the national office market is showing signs of bottoming. The latest monthly data
through this past November show that occupied space has increased by more than 2 million
square feet in the past couple of months, indicating a welcome increase in leasing activity.
Positive results for 2010 were driven by buildings in CBDs, which absorbed 1.37 million square
feet through November. By contrast, suburban office markets lost almost 10. 5 million square
feet of occupied space.
Vacancy rates for CBDs have trended about 300 basis points less than vacancies for suburban
markets for most of the past decade. This wasn’t the case in the 1990s, however. From ’93 to
’98, suburban vacancies hovered around 12 percent while CBD office buildings, burdened by
high crime rates, posted vacancies that averaged near 14 percent.
In the ’90s, households left cities in droves, choosing to live in suburbs, which typically of-
fered better schools and less crime. Job creation followed these demographic trends, and
developers took careful notes. From 1990 to ’98, 238 million square feet of new office space
— roughly 75 percent of total new completions — were created in suburban markets.
Cities began recovering in the late-’90s as crime rates dropped. Proactive government policy
encouraged employers to return to downtown areas, and office vacancies in CBDs dipped be-
low suburban market vacancies in ’99.
The near-term outlook for
CBD and suburban office
markets will mirror recent
performance. We expect
office properties in CBDs
to drive the sector’s re-
covery in the next couple
of years.
CBD VS. SUBURBAN OFFICE VACANCIES
Also, trends in telecom-
muting imply what may be
a significant shift in rela-
tive demand for CBD ver-
sus suburban office space.
Telecommuting didn’t de-
press demand much for
office space in the ’90s because suburban office space offered an optimal balance of re-
duced commute times and access to office infrastructure such as phones, fax machines
and copiers. Improvements in information and mobile technology in the past few years,
however, imply that a lot of office work can be done from home, reducing commute times
to zero.
Source: Reis Inc.
CBDs will continue to attract workers in service industries such as finance and law because
of the need for face-to-face interaction. Trends that support working from home have yet to
impact overall demand for office space seriously, but on the margin, they may mean less de-
mand for suburban office space.
Reis expects that office vacancies will have peaked at about 17. 5 percent at the end of 2010
and will decline to 17.2 percent by the end of 2011. Even if job growth remains moribund, the
office sector is set to absorb about 25 million square feet of space in 2011, given favorable
supply conditions.
Most of these positive developments will be concentrated in CBD areas, as suburban markets
continue to underperform.
Victor Calanog, director of research at Reis Inc., writes a monthly column on property types for Scotsman Guide.
As head of Reis’ core economics team, he is responsible for data models, forecasting, valuation and portfolio
services for clients in commercial real estate. Reach him at victor.calanog@reis.com.
Faruk Ozdemir, senior manager for Reis’ quality-control team, contributed to this article.
To read previous Property TypeCast columns by Victor Calanog, visit sctsm.in/calanog.
Q A &
Jamie Woodwell VICE PRESIDENT OF COMMERCIAL REAL ESTATE RESEARCH MORTGAGE BANKERS ASSOCIATION
BY JENNIFER E. GARRETT
Sales activity for commercial properties has been
sluggish since the recession hit. Will 2011 be a turn-
around year for the market? Jamie Woodwell, vice
president of commercial real estate research at the
Mortgage Bankers Association (MBA), tells us what
the financing landscape will look like this year in a
preview of this month’s MBA Commercial Real Estate
Finance/Multifamily Housing convention.
Moody’s Investors Service reported a 4.3-per-
cent increase in commercial property prices this
past September. Are prices trending higher?
What we’re starting to see is a firming and, certainly
in some sectors, the beginning upticks of property
prices. Commercial properties saw about a 40-per-
cent peak-to-trough decline during the recession.
Because of the way those prices are recorded and
the time it takes to actually effectuate a sale, the
prices we see in the market for commercial proper-
ties [aren’t reflected in the research] as quickly as
what you see in other markets.
What are some of the bright spots in the
commercial mortgage market today?
Trepidation about the single-family housing market
and the move away from homeownership created a
real surge in demand for multifamily and rental prop-
erties. We’ve seen asking rents increasing there and
vacancy rates decreasing. For other property types,
we’ve seen stabilization coming to those property
fundamentals, as well. Vacancy rates seem to have
steadied in the office, retail and industrial markets.
The general stability that we’re starting to see in the
economy is filtering through to the commercial real
estate market, and that’s a very good thing.
What areas are picking up?
Investors are looking primarily for two types of prop-
erty: either good, stabilized properties that they can
be confident about their continued operation, or
value-added properties that they can perhaps get a
discount on now and benefit from as the economic
tide rises. For a while, there has been more investor
demand than there has been supply. For property-
owners who have properties that are cash flow-
ing, there’s been little incentive for them to sell. As
prices rise and fundamentals stabilize, we might see
a little bit of a change in that.
What advice do you have for mortgage brokers
this year?
Over the past two years, we’ve seen low origina-
tion activity, and that’s been driven by a lack of de-
mand from low sales activity and little incentive to
refinance. Looking ahead, we will see increasing
loan-maturity volumes. As prices stabilize and start
to rise, we’ll see a little bit more incentive to either
finance or transact on a property. All of that should
lead to increases in origination volumes in each suc-
cessive year going forward.
Jennifer E. Garrett is an associate editor at Scotsman Guide.
Reach her at (800) 297-6061 or jenniferg@scotsmanguide.com.