With residential real estate in a slump, many investors are searching for other alternative investments to help offset potential losses in their investment portfolios. Other investors are seeking to take advantage of a weakening economy and high foreclosure rates. Commercial properties are a popular choice, as they can carry much bigger payoffs than residential properties.
Researching commercial real estate is an essential step to take before deciding what and where to purchase. With hotel, office, retail, multifamily and industrial real estate markets and industry reports to wade through, the research can be overwhelming. Knowing how to use reports and numbers to inform potential purchases is a critical step in becoming an informed investor. The following research covers the United States commercial real estate and factors that influence market performance.
A brief history
Similar to the nature of residential real estate in the late 80s to early 90s, overbuilding and high interest rates caused a stagnant market. The majority of commercial properties were owned by a small percentage of individuals and corporations. While it may seem wise to sell to make a profit or recoup losses, the tax benefits worked in their favor—empty properties provided excellent tax write-offs. Laws eventually changed and properties sold quickly on the open market, making sellers very wealthy. The U.S. economy also flourished during this time and rental rates increased at a steady rate. From the mid to late 90s, commercial real estate boomed.
The technology sector was a large contributor to the healthy market conditions. In 2000 when the industry fizzled and left stock market investors empty handed, those companies that declared bankruptcy also terminated their commercial property leases. Vacancy rates skyrocketed seemingly overnight. The market made a fairly quick recovery in 2001 as vacancy rates declined at a moderate rate. Since then, commercial vacancy rates nationwide have remained low. 2007 reminded property owners that fluctuations occur. In April, for the first time since the Moody's/REAL Commercial Property Price Indices (CPPI) began, commercial real estate prices recorded their first year-on-year decline, dropping 2.8 percent compared to April 2007. However, the CPPI shows that commercial real estate prices have increased 9.1 percent in the past two years.
Conclusion: Commercial real estate is affected by businesses in that particular industry. Following is a brief rundown of what is happening on a national level.
Increasing foreclosures have brought greater demand for leased apartments
Purchasing an apartment complex appears to be an attractive investment as the national foreclosure rate steadily climbs. As news of Ed McMahon facing foreclosure breaks, Americans are realizing foreclosure is not linked to socio-economic status or low-end homes. These days, many homeowners owe more than their home is worth. Without equity and the potential of a down payment for a smaller, more affordable home, many face foreclosure on their homes and turn to renting. They say goodbye to their 3,000-square-foot homes and enter into a lease for an 800-square-foot apartment.
“Nearly 1 percent, or roughly 447,723 loans, fell into foreclosure during the January-to-March (2008) period, the Mortgage Bankers Association said. That surpassed the previous high of 0.83 percent over the last three months in 2007,” Jeannine Aversa of the Associated Press reported June 5. These numbers are slated to grow as sub-prime lending practices continue to catch up with under qualified borrowers. Creative financing options through government and bank programs have nearly disappeared, so many will be left with few options.
Based on data provided by RealtyTrac, military towns such as Des Moines, Iowa, are being hit the hardest by foreclosure—at four times the rate that other cities are experiencing, according to Bloomberg News. "Military families were targeted as customers during the boom in subprime lending because their frequent moves, overseas stints, and low pay meant they were more likely to have weak credit ratings, said Rudi Williams of the National Veterans Foundation in Los Angeles," according to Bloomberg News.
What does this mean for commercial real estate investors? Apartments are a hot commodity in many locations.
The Seattle apartment rental market has decreasing inventory and increasing prices, Condé Nast Portfolio reported June 5. With a vacancy rate of 3.5 percent and rents up 7.7 percent from one year ago, it seems that an investor can’t lose. Factors that contribute to the market include strong job growth and above-average home prices. But will the growth hold? According to the article, yes, although the vacancy rate may drop slightly because additional units will become available as building continues.
“Major findings in this survey of the professionally managed rental apartment industry show a distinct improvement of the economics in the market rent segment of the rental apartment market with NOI (net operating income) rising and a lower economic losses rate,” according to the National Apartment Association's 2007 Annual Report. That’s a lot of words to say apartment complexes are profitable as an industry.
Conclusion: Hot market and real estate. Apartment buildings will be sold at a premium in this market. Be aware of local job markets, housing rates and foreclosure rates to maximize returns. Consult a commercial property broker for reports specific to particular locations.
Retail spaces
As consumers cut back, dwindling business will create less demand for retail real estate
Americans love to shop and spend money. Or so it was thought. National spending is down as the price of gas and food soar. Americans have shifted to buying the necessities while foregoing luxury items. From April to May, 27,000 people lost their jobs, the majority from department stores and gasoline stations, according to the Bureau of Labor Statistics.
In the midst of gloom and doom, there is good news. Online shopping is projected to reach $335 billion by 2012, up from $175 billion in 2007, according to a report on Forrester Research, an independent technology and market research company. Foot traffic in retail stores may decrease while online shopping increases; this may be good news for industrial real estate owners.
Conclusion: Real estate and market not hot. Again, consult a real estate professional to receive reports on a particular area to verify trends. Even if gas prices are increasing by the day, maybe Americans will stay close to home and shop in air conditioned stores in order to save on their electricity bills.
Office parks
Medical office parks could be the wave of the future. An aging baby boomer generation means that retirement homes and the medical field in general will be in higher demand. As a commercial property investment, there is relative stability projected for the years to come. According to the Employee Benefit Research Institute, spending on health care in 2006 accounted for 16 percent of the GDP, and will continue to rise. While most sectors are losing employees, the health care industry is adding employees.
The U.S. market is going global more and more each day. So what does this matter to the local commercial property investor? It means that tenants depend on the conditions in foreign countries to provide products and services for the health of their company. When the income producing potential of properties depends on tenants, tenants should be interviewed and business plans carefully evaluated. As businesses extend their reliance on products and people overseas, U.S. businesses will have greater needs to be located on the Pacific and Atlantic coasts.
Speculative development of nearly all kinds is all but dried up. Financial institutions are still taking a hard hit from the economy and loan practices of the recent past. Established developers may have an easier time receiving financing with the rest of the industry needing large cash reserves.
Conclusion: Some hot. Some not. No surprises here—consult a commercial real estate professional for more information about local markets.
Industrial
Though the industrial sector is slowing, industrial real estate is worth considering
The unemployment rate in construction and manufacturing trades is increasing, which means business health is not great this season. In addition,
a weakening U.S. dollar can mean big trouble for any local manufacturing companies that have to import parts. The weak dollar, though, is generally a benefit for manufacturing companies. “Manufacturers find themselves caught between rising costs and weakening demand in many industries. Exports continue strong due to the weak dollar—without the weak dollar the story would be much more negative in manufacturing,” according to the May 2008 Manufacturing Institute of Supply Management’s
Report on Business.
Even so, industrial real estate may still be a good investment. “In each marketplace, industrial product (compared to retail, office and multifamily) typically enjoys a lower price per square foot, lower rent per square foot, high barriers to entry, tolerant tenancy, good occupancy, low turnover, minimal costs for turnover, and great demand, even in down trending cycles with tenants coming out of better class office product to flex, or even nicely presented industrial,” according to the Top 10 Markets to Watch report by Sperry Van Ness Commercial Real Estate Advisors.
Conclusion: Real Estate Hot. Market not. Certain industry sectors are still outperforming the averages so the market is not in the dumps, it’s just not hot. Keep in mind this is a national average, so results may vary significantly by area.
Hospitality
Similar to the retail industry, the hospitality sector takes a hit when transportation prices soar and unemployment rates rise. Despite this news, New York is building new hotels and plans for selling others are in the works, Michael Stoler of the New York Sun reported April 17.
The rest of the nation is feeling reduced amounts of tourism. Smith Travel Research, Inc’s Weekly Lodging Report for the week of June 8 through 14, 2008, shows that national occupancy rates are down 3.9 percent from last year, with room rates up 3 percent. Overall revenue was down 1 percent from last year. Even this moderate decrease can be a substantial hit to new investors.
Conclusion: Not hot. It may be a promising market for New York, as they receive a large population of foreign travelers and not feeling the loss of business travel. The rest of the nation will probably feel the pinch quite a bit more. Until the economy levels out, there may be more hard knocks than most investors can take.
And that is commercial real estate in a nut shell. Of course, a stalling economy and downturned market is sometimes a great time to invest. Consult commercial real estate professionals and economists to determine which markets and sectors may be better investments.
