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Wednesday, August 1, 2012

Commercial Real Estate Forecast: 2012-2013

The other shoe has not dropped. During the housing crisis, many people asserted that commercial real estate was the other shoe waiting to drop. Commercial real estate loan defaults did rise along with residential defaults, but the commercial sector never went down enough to throw the financial system into crisis.

Now the non-residential real estate sector is showing some signs of life. Downtowns across the country are seeing occupancy increases, though the majority of suburban markets are still languid. In the boom years, many suburban office properties were occupied by real estate and title companies, which have since downsized significantly.

The most important aspect of the current market is the lack of new supply. There are some projects underway, and the non-residential construction data show a bit of improvement. Generally, though, there are trivial amounts of speculative new space coming to market. So far that has not been a problem: there’s been no need for new office space, given the very slow pace of job growth.

Looking forward into 2013, though, employment should improve. This assumes that the rest of the world makes progress. Vacancy rates will fall and landlords will start nursing their rents upward. If we ever get a real surge of employment, then many local markets will be caught with insufficient supply. However, that surge is an upside risk, not part of the main economic forecast.

The commercial real estate firm of Tishman Speyer acquired 1110 Vermont Avenue NW Washington, D.C.
1110 Vermont Avenue NW (center building) in Washington, D.C., in the United States. This is a 12-story high-rise office building constructed in 1980. The commercial real estate firm of Tishman Speyer acquired 1110 Vermont Avenue NW (which has 305,000 square feet of interior space) for more than $103.5 million. To the left is 1100 Vermont Avenue NW, a building designed by Vlastimil Koubek and built in 1979. To the right is 1120 Vermont Avenue NW, a 12-story office building constructed in 1981. (Photo credit: Wikipedia)
Businesses have two main risks today (July 2012), both external to the country: Europe and China. Europe is in a mild recession which could turn very ugly. “Muddle through” is the most likely forecast, but a severe recession is possible. China’s economic growth has decelerated and is at risk of continuing to drop, despite recent attempts by the government to spur the economy forward. It’s quite possible that China’s economic leaders will be no more able to fine tune their economy than Ben Bernanke is able to fine tune ours. If Europe melts down while China stumbles, our strong export sector will decline. Financial markets might also freeze up, though I think that’s a remote possibility. In such a scenario, the United States goes into recession, commercial vacancy rates rise, rents fall, and new construction is delayed even longer. This is the negative extreme, but it bears some consideration.

In today’s commercial real estate environment, tenants should try to extend their leases as long as possible. Landlords should try to wait out this slump in anticipation of rents firming next year and into 2014. Contractors should take up stamp collecting—they’ll have plenty of time on their hands before new projects start to pencil out.

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