Talking Points by Bob Bach

Q3 Leasing Market

1. Absorption has turned positive for all major property types: apartments in 2010 Q1 (Reis), industrial and office in 2010 Q2 (G&E), retail in 2009 Q3 (CoStar). Apartment absorption has been brisk, but the recovery is going to be slow for the other three property types.
2. The construction pipeline is largely empty, and there are few new starts.
3. Vacancy has peaked for all property types and is coming down at a moderate-to-brisk pace for apartments, very slowly for industrial, office & retail. Quarter-end vacancies: Apartments @ 7.1%, a very sharp decline from 7.8% in Q2 signaling that the apartment recovery will be more robust than many thought during the depths of the Great Recession. Industrial @ 10.6%, down from 10.7% in Q2. After a surge of demand in Q2, the pace of recovery pulled back in Q3. Office @ 17.8%, down from 17.9% in Q2. Market has barely budged in past three quarters due to anemic pace of recovery in labor market. Retail @ 7.4%, down from 7.5% in Q2. This sector is recovering earlier than was expected 12 to 18 months ago. Unemployment is high (9.6% in Sept.), but 90% of labor force is still employed, and some pent-up demand is driving the market. Upper income households are spending again, too.
4. Asking rental rates have broadly stabilized, and some Class A properties in certain markets such as Manhattan and San Francisco have been reducing concessions packages.
5. The labor market has added 874,000 payroll jobs year-to-date through October and 1.1 million in the private sector. Credit is readily available through the capital markets for large companies, but small companies continue to have trouble accessing bank credit. Facility consolidations are still happening.
6. Biggest risk: The economy continues to struggle. A double-dip recession is unlikely, but the rate of growth is weak. The economy’s immune system is compromised, meaning that unforeseen events could reduce the already-low levels of confidence. There is not much energy in the leasing markets, and there could be stops and starts. For example, second quarter industrial absorption was strong, reflecting growth in manufacturing exports beginning in the second half of last year, but third quarter absorption was disappointing.

Q3 Investment Market

1. Sales transactions year-to-date through Q3 totaled $60.4 billion of apartment, industrial, office and retail properties valued at $5 million and up – 82% above the same period in 2009.
2. Transaction volume has picked up every quarter this year on a sequential and year-ago basis. Compared with a year ago, volume was up 49% in Q1, 85% in Q2 and 105% in Q3.
3. Transaction $ still low by historic standards with further increases expected.
4. Prices appear to have stabilized overall judging from Moody’s/REAL commercial property price index and the NCREIF database.
5. Investors are focused on the upper end of the quality spectrum – core properties in primary markets. This is evident in the average deal size of $21.3 million year-to-date versus $14.1 million during the same period in 2009. Although the dollar volume of transactions has risen by 82% this year, the number of transactions is up by just 20%.
6. Biggest risk: Unforeseen spike in interest rates or a double-dip recession.

Forecast

1. Expect the leasing market recovery to be slow and uneven until the labor market picks up. Job growth could be disappointing in 2011, perhaps in the range of 1.5 to 2.0 million – which would leave a remaining deficit of around 6 million and a year-end unemployment rate of around 8-8.5%.
2. Expect the investment market to continue gaining momentum in 2011 unless interest rates rise unexpectedly. Federal Reserve officials and many economists think this is unlikely because there is so much slack in the labor market, real estate, factory utilization, etc. But there is a small chance – perhaps 10% -- that investors could pull back from U.S. Treasuries due to their meager returns, weak dollar and huge increases in supply, which could cause a spike in inflation and interest rates.