ABA Banking Journal 5/08 - (Page 56) briefing The Economy MARK VITNER Senior Economist, Wachovia ANIKA R. KHAN Economist, Wachovia Could housing tremors shake commercial real estate? THE ABRUPT COLLAPSE OF THE subprime mortgage market and severe correction in home construction and prices has raised concerns the same thing could happen to commercial real estate. When considering the impact of property types, office and retail will feel the brunt due to slower employment growth and consumer spending. Office fundamentals remain strong, but tenant demand has slowed along with the overall economy. Office employment has decelerated recently but is still up solidly year over year. With the economy slowing, assumptions in office deals are becoming more conservative. Investors are also taking a more cautious view of retail space as sharply higher gas and food prices have cut deeply into discretionary spending. A few chains are clearly struggling and worries about rent growth and tenant quality are weighing on property values. The industrial market remains reasonably healthy, but demand will likely wane in the near term. Businesses are striving to reduce inventories throughout the production and distribution pipeline. Imports are also growing more slowly, which should cut into demand at some of the best performing warehouse markets. Hotels are the one product that has seen significant new supply, particularly in the limited service category. So far, however, demand has held up reasonably well. Revenue per available room increased over the past year and occupancy rates are relatively high. But slower economic growth will likely cut into business travel. The apartment market is receiving a great deal of attention because of the extreme weakness in the housing market. One school of thought has been that apartments would benefit from that weakness. On the other hand, struction. We expect prices for commercial properties to fall around 1520% nationwide and look for commercial construction to decline 20% over the next two years. Credit quality is generally better in the commercial market than in residential and there are significantly fewer speculators and novice investors. Commercial real estate $200 $175 $150 $125 $100 $75 $50 6.00 $25 $0 1995 5.00 1997 1999 2001 2003 2005 2007 9.00 12 month moving average Price per square foot: Q4 @ 174.37 (left axis) Cap rate : Q4 @ 6.31 (right axis) Vacancy rate : Q4 @ 8.61 (right axis) 11.00 10.00 8.00 7.00 Source: Reis, Inc., PPR, NREI, Real Capital Analytics and Wachovia there are a glut of rental properties available today, most of which are not measured in the formal vacancy surveys. This shadow inventory will likely hang over the market for the next few years. While we do not expect history to repeat itself, the commercial real estate market is headed for a major correction. Most of the correction will be in property values and commercial con- Commercial properties are also generally performing well, vacancy rates remain low, and delinquency rates remain near historical lows. There is also relatively little supply in the pipeline. This lack of new supply should ultimately limit the slide in commercial property values. BJ This article is a summary of a longer article, published in our digital edition, accessed from www.ababj.com. 56 MAY 2008/ABA BANKING JOURNAL www.ababj.com/subscribe.html http://www.ababj.com http://www.ababj.com/subscribe.html
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