New Construction Strains Property Fundamentals

In the midst of economic chaos, one of the bright spots in the commercial real estate industry has been a relatively subdued level of new construction in the past few years, as increasing rents and declining vacancies have propped up property fundamentals.

However, new reports from New York-based research firm Reis show a worrying increase in the level of new construction activity in 2008, just when the office, industrial, apartment and retail markets are at their most vulnerable to decreases in demand for space.

In the apartment sector, for example, Reis is projecting new completions to total nearly 98,500 units in 2008, up from 86,220 units built in 2007. The national vacancy rate will climb to 6% from 5.6% in 2007, the highest level since the 6.7% vacancy rate recorded for 2004.

More construction is also coming online in the community/neighborhood shopping center sector, with nearly 34 million sq. ft. set to deliver in 2008, the highest level since the 34.5 million sq. ft. of new construction delivered in 2005. More troubling news is that vacancies will climb to 8%, up from 7.5% in 2007, the highest level since Reis began keeping retail records in 1999.

One of the most closely watched supply barometers is the office market, where Reis is forecasting nearly 62 million sq. ft. set for completion in 2008, up 13% from the 53.5 million sq. ft. built in 2007. Vacancies will also climb to 13% for 2008, up modestly from the 12.6% notched last year.

The most positive fundamentals will manifest in the less-than-sexy industrial sector. Reis is forecasting 73.8 million sq. ft. of new industrial space to be completed in 2008, slightly below the 77 million sq. ft. brought on stream in 2007. Vacancies will be flat in 2008, at 9.7%, but will steadily drop to 8.8% by 2012.

The new construction boom looks set to wane come 2009 and beyond, however. According to the Federal Reserve’s latest survey of senior loan officers, 80% of domestic banks tightened their lending standards on commercial real estate in the fourth quarter of 2007. That is the highest percentage recorded since officers were first asked the question back in 1990.

While slower construction volume should bode well for property fundamentals, economists say it might have the opposite effect on the fragile U.S. economy. Nonresidential building added just under half a percentage point to economic growth in 2007, helping to prop up total GDP. In future years that comfy addition may be lost.
TAGS: News
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