New wave band the B52s could have been talking about today’s commercial real estate market in their 1980 hit “Party Out of Bounds” when they questioned: Who’s to blame when situations degenerate?After years of everincreasing commercial real estate sales volume and evercompressing cap rates, the party seems to be on the verge of ending — but why?By most fundamental measures, commercial real estate is in great shape.Supply and demand for most property types, with minor market specific exceptions, is distinctly in balance across the country. According to reports from the major commercial brokerage houses, fundamentals are strong.Brokerage Jones Lang LaSalle indicated in its first quarter summary regarding industrial properties that absorption of space in the first three months of the year exceeded new construction deliveries and the U.S. vacancy is at 6.2 percent, a 16 year low.
Likewise, Marcus & Millichap said in its U.S. office investment outlook for 2016 that about 90 million square feet of space would be absorbed nationally this year and only 79 million square feet will come online, which will bring vacancy rates down. Supply and demand are balanced with upward pressure on rental rates, if anything.Investment advisory firm ARA Newmark said multifamily vacancy across the country increased 0.10 percent to 4.50 percent, according to its firstquarter market review.While vacancy is increasing and could bloat to 4.70 percent by year’s end, the report cites a National Multifamily Council estimate that 300,000 units to 400,000 units need to be delivered annually to keep up with demand, but only 230,000 units will deliver this year.
Not exactly a bad fundamental story, but one to watch.Vacancy rates among retail properties are down to 7.9 percent and are expected to drop for the next four quarters while rents increase, according to a report by brokerage Cushman & Wakefield’s national office. Good fundamentals show rates rising with vacancy dropping.Across the four main property types, it would be hard to argue that anything is wrong.Yet, that is what the feeling is in the market.In the meantime, no one can blame commercial mortgage rates for the party coming to an end.Rates are still ridiculously low. Top quality lower leverage deals are pricing aggressively in the 3 to 3.5 percent range for five and 10year deals, respectively, according to the John B. Levy & Co. Mortgage Survey.
Conduit loans are back and pricing closer to 4.5 to 4.75 percent for full leverage 10year loans.Most of the anxiety in the market seems to be coming from global weakness and volatility in the oil market.More specific to the U.S. is the fact that the current expansion is distinctly long in the tooth, and many real estate investors have spent the past three or four years building up portfolios they are very happy with and don’t want to blow all that with a few late in the cycle purchases that drag returns down.So for now, the market is going to take a breather.Depending on the property type, fundamentals in the Richmond region are mixed. However, significant amount of transaction volume has been recorded in the Richmond area.
The best explanation for the apparent contradiction is that most of the transaction volume nationally comes from the top tier markets, and those markets are clearly taking a breather.The second tier markets, like the Richmond area, are benefiting to some extent as they have not experienced quite the runup that has occurred elsewhere and still have active buyers.Knight, Dorin & Rountrey, the Hanover Countybased real estate appraisal and consulting services firm, found in its most recent annual real estate survey that “growth” is the stage of the property cycle where most of the respondents believed the Richmond area is experiencing. The survey has been conducted for 24 years and is based on responses from more than 200 real estate professionals in the central Virginia region.The majority of respondents also indicated that the cycle for multifamily and hotel properties is “mature,” with about 63 percent favoring that classification over the recovery, growth, mature or recession choices.The party is not out of bounds yet. Investors are just in the powder room.
