Surveying the Landscape Investors nervous about real estate fundamentals might breathe a bit easier after reviewing the latest data from CB Richard Ellis for office and industrial markets, nationwide. by Barry Vinocur

Much of the discussion about the potential for oversupply has focused on offices and hotels. However, concern also has been expressed about apartments. The focus here will be on office and industrial markets because the two are so closely linked in the minds of many investors (a number of companies are classified as office/industrial REITs) and because the two sectors make up such a significant portion of the industry’s market cap.

The following analysis was prepared by CB Richard Ellis (www.cbrichardellis.com).

Office Markets
The second quarter 1998 CB Richard Ellis National Vacancy Index exhibited continued improvement in the national office market, but reflected moderation in the rate of that improvement. The national vacancy rate, which is now at 9.2%, is down 30 basis points from the first quarter. The decline was achieved through improved performance of downtown office space, which declined 60 basis points to 9.7% in the second quarter, rather than from suburban markets, which remained flat at 9.0%.

Vacancy rates are at levels not evident since the history of the index, in the mid-80s, CB Richard Ellis reports. With 33.2 million square feet absorbed to date, 1998 looks to be a super year for office building landlords and another tough year for tenants looking for new or expanding office space. Net absorption—the change in occupied space—continues to be very robust across the country, reflecting the strong U.S. economy. During the second quarter of 1998, 17.7 million square feet of space was absorbed in contrast to 15.5 million square feet in the first quarter.

Nevertheless, some possible impacts of the Asian crisis may be reflected in local numbers. While the national picture continues to be rosy, there are areas of the country that show either some economic contraction in the demand for office space or new development, which is pushing vacancy rates up slightly, CB Richard Ellis notes. For instance, the second quarter vacancy rate jumped 80 basis points in Dallas. This reflects over one million square feet of new buildings brought into the market, which exceeded demand.

Las Vegas is another market showing a large amount of supply relative to demand. This drove the vacancy rate up 230 basis points in the second quarter of this year, after a rise of 210 basis points in the first quarter. Currently, the Las Vegas vacancy rate is 15.3%, and it was not long ago that this market had one of the lowest vacancy rates in the country. Other markets showing a similar pattern are Nashville, Tennessee; Phoenix, Tampa, Florida; and San Jose, California. With the supply of new space one of the important issues facing tenants and landlords for obviously different reasons, CB Richard Ellis, on a regular quarterly basis, has been following the amount of space under construction in the various markets around the country.

Recent figures show that there is almost 60 million square feet of office space under construction for delivery this year. This is about in balance with the national expectation for demand. Importantly, the new space brought into the market in 1998 has been leased at historically high percentage levels before receiving certificates of occupancy. For the second quarter about eight million square feet of new multi-tenant buildings were brought into markets followed by CB Richard Ellis. Of this, about 51%, or four million square feet, was already leased. Put another way, these buildings were 49% vacant at the end of the quarter.

Is this something to be concerned about? Are some markets experiencing increasing supply with demand starting to slow? The graph (at left) shows the lease rate experience of new buildings over the past 12 years. The lease rate was down in the 30% range in the late 1980s when the building boom was underway. The percentage declined sharply between 1988 and 1989, prior to the real estate crash of 1990. Now it is at 51%, which is still healthy, although not at the peak levels of the mid-90s. This implies that although supply is increasing in some markets, speculative building is still not widespread, according to CB Richard Ellis.

Overall, the office market is still quite healthy with some signs of the pace of occupancy growth slowing. On a national basis (see table on page 46), this reflects a good balance of supply and demand factors, with net absorption and new supply about equal. Some local markets do show some evidence of supply beginning to exceed demand, but to date these markets are few in number.

Industrial Markets
The national industrial availability rate increased 0.3% in the second quarter of the year, to 8.6%, according to CB Richard Ellis. The yearly change is 0.5%, from 8.1% in the second quarter of last year. Over the past year, the rate has appeared flat, despite the large amounts of space being completed nationwide.

Nationally, demand remained strong, keeping supply and demand in balance. In many markets, however, the increase in space available is largely the result of oversupply. Demand remains strong, due to the continued rapid pace of expansion of the overall macro economy. Consumer spending is very high and business investment is robust. The economy appears to be operating at full capacity, with the lowest unemployment rate in 30 years—4.3%. Labor markets remain tight, resulting in increasing labor costs. Inflation continues to fall, with the CPI currently at 1.5% and producer prices falling.

Industrial availability increases are evident nationwide, with the rate increasing in three out of four regions. The availability rate increased the most in the East, 0.4% to 10.8%. The East maintains the largest regional availability rate. The next highest is the South, at 9.8%. This rate remained unchanged between the first and second quarters of this year; however, the yearly change is 0.9%. The West has an availability rate of 8.4%. This is an 0.2% quarterly increase. The lowest regional rate is in the South, at 6.5%, which is a 0.3% quarterly increase.

While the Asian crisis may create a slowdown in demand for manufacturing goods over the next year, overall demand remains robust in many markets. Economic growth, however, is anticipated to abate in the near future. One reason is due to a weakening trade balance with Asia Pacific, the result of demand for exports falling and the trade deficit increasing. Another reason is the decline in growth of corporate profits, with the most important contributing factor being increasing labor costs. Overall, the economic growth rate (that is, GDP) is expected to fall from nearly 4% this year, to almost half that next year. This will surely have an impact on industrial markets (that is, weaker demand) nationwide.

Download a copy of the Office Vacancy Index Historical Data

Surveying the Office and Industrial Market The CB Richard Ellis Office Vacancy Index measures the vacancies in downtown, suburban, and metropolitan areas of the United States. The index is based on a quarterly survey of major office buildings. Each individual index is computed as a percentage, dividing vacant space for lease by the total square footage of office space in each area. The index covers major competitive multi-tenant office buildings. Buildings excluded are government-owned, medical, office condominiums, and those that are not competitive in today’s marketplace. The majority of the buildings have been constructed since WWII, although those that have been renovated are also included. Newly constructed buildings are added to the survey upon completion. The downtown index typically covers office buildings in the central core of the largest city within the metropolitan area. The corresponding suburban area includes the remainder of the metropolitan area (excluding the central core). In a few metropolitan areas there is no single major central core area (for example, Orange County, California) and the entire metropolitan area is classified “suburban.” The CB Richard Ellis Industrial Vacancy Index measures the supply of available space in large industrial buildings as a percentage of the total amount of such space. The index is based on a quarterly survey of large industrial properties. All industrial properties that can accommodate a tenant requiring 100,000 square feet or more are included. Available properties include both vacant and occupied available space in existing and under-construction buildings (within six months of completion).