New Report: Occupancy Growth Hits a Wall

Landlords are savoring some well-deserved occupancy gains. They may need to enjoy them while they last. An Oct. 27 research report from Property & Portfolio Research (PPR) predicts that vacancies in all classes of real estate (except office) will register above current levels by 2011. This shouldn’t be misread as dire news, however. Tight occupancy will allow most landlords to hike rents, and the tightest markets can absorb plenty of new development.

Boston-based PPR doubts that vacancy will continue dropping at the pace that it has been during the past few quarters. Between mid year and the end of September, for example, office vacancy dropped by 0.2% to 16% in the steepest decline of any property type. But PPR expects office vacancies to fall by just 0.1% between the end of September 2006 and the end of September 2007. That’s a meager drop, too: The previous twelve-month period saw office vacancies decline by 0.9%.

“The office market has done pretty well with what most economists are calling mediocre job growth in recent months,” says Bob Bach, director of national research at Oak Brook, Ill.-based Grubb & Ellis. Bach doesn’t expect office vacancy to drop quite as dramatically next year as it has in 2006.

The apartment market will also be challenged to bring vacancy down over the next 11 months. Apartment vacancies are only expected to drop by 0.2% to 5.5% by the end of September 2007. Like the office market, apartment vacancies fell sharply between September 2005 and 2006 (try 0.7%).

“We’ve really seen a shift over the past 12 months as more people have gravitated towards renting an apartment versus owning a home,” says Mark Obrinsky, chief economist at Washington, D.C.-based apartment trade association National Multi-Housing Council. His bullish outlook hinges on solid economic growth in 2007, plus declines in single-family home values.

While apartment and office are following similar paths over the next year, the office sector is poised to thin vacancy further within the next five years. PPR projects that the office market recovery will resume after next year, pushing vacancies down by 1.3% between early 2007 and the 2011.

For the near term, PPR expects some markets to outshine the herd. Sixteen markets should see a vacancy decline of roughly one percentage point between now and the end of September 2007. The leaders, in order, will be New Orleans office, Raleigh retail followed by San Jose office, in third place.

Some of these markets are in bad shape now, however. The New Orleans’ office market was 26.5% vacant at the end of September. San Jose, where the technology bust is still being felt, is grappling with 20% vacancy. And Raleigh’s retail market is coping with the after-effects of a construction boom that’s thankfully come to an end.

“While the occupancy recovery is largely over in many markets, rent growth projections are still healthy,” reads the report. “Upcoming rent growth in the apartment and office markets will outpace that of the past year. The picture is not so rosy for retail and warehouse markets, where rent growth is slowing, but still-decent growth is projected in the near term.”

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