The 2009 Outlook for US Commercial Real Estate

For the balance of 2009, investors in US commercial real estate have to be prepared for a great deal of bad news concerning basic trends in the industry. Vacancy rates will be rising in virtually all segments of the real estate market; rental rates will be falling in practically every geographical market around the country; new construction projects will be cancelled; and tenant bankruptcies will permit lease cancellations with increasing frequency.

This bad news can be expected to continue at least until the recession is over. The fundamentals of commercial real estate always lag economic fundamentals. An economic recovery has to be in place for a period of time before a company decides to stop retrenching and to lease more office, retail or logistics space. Therefore, bad news can be expected to continue for some time. The first sign of an improving real estate market should be a decline in the amount of sub-lease space being offered, and gradually this will lead to an overall rise in occupancy rates and eventually in rental rates.

But investors have to focus on two important points. First, investment markets – whether common stocks, bonds or real estate – always anticipate the future. The stock market will not wait until the recession is over before it begins to rally in anticipation of the recovery that is expected to take place six to twelve months in the future. Similarly, the real estate market will not remain static with no movement in price until vacancy rates are declining and lease rates are rising. Prices will always be at their lows when things appear to be the darkest.
The second thing that must be remembered is that when investing in real estate the investor is not buying the market, but is buying an individual and discrete piece of real estate. Real estate is not like the stock market where there is a high degree of correlation between all segments of the market. The real estate market is inherently an inefficient market and particular opportunities arise for a variety of reasons. With the very serious problems affecting the credit markets today, Falcon expects that during the balance of 2009 there will be a significant number of extraordinary opportunities to acquire high-quality, conservative real estate at very attractive prices. As the fundamentals of the real estate market follow the improvement in the general economy in 2010, more capital will be attracted to real estate at that time and the number of good buying opportunities can be expected to decline as 2010 progresses.

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The Market Fundamentals

Falcon has just completed a review of the office markets in 14 major markets around the United States and our acquisition representatives and asset management staff report that vacancy rates are rising in each of them. The vacancy rates range from a low of just under 9% in Boston to close to 20% in Phoenix and in all cases vacancy is expected to rise going forward in 2009. As the recession continues, corporations are downsizing and reducing their space requirements, thereby adding to the amount of vacant space on the market. There are also cross-currents between Class A and Class B space, with some tenants opting for less expensive space in Class B buildings, while others seek to take advantage of significantly lower rents for Class A space. While little or no new construction is anticipated in any of the major markets, there are still buildings that are being completed in markets such as Washington DC and Chicago and these buildings will come on the market later this year or early in 2010. New York and San Francisco, on the other hand, have virtually no new office construction in the pipeline.

What has to be emphasized is that the current recession affects some geographic markets more seriously than others. The commercial real estate market in Houston, which is considered to be the oil capital of the United States, is seriously affected as oil companies delay their expansion plans following the dramatic decline in oil prices. New York and San Francisco, which are major financial markets, are negatively impacted by the crisis in the financial markets. On the other hand, Washington DC suffers a good deal less than most parts of the country since the local economy is supported by the vast expansion of the Federal Government. And the Boston economy is more resilient since it has a strong position in industries related to technology, biology, education, and healthcare, all of which are somewhat recession resistant.

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