A cacophonous media assault on residential real estate values in September and October gave occasion for pause to even the steadiest hand and strongest constitution. Despite the apparent irrelevance to the rationally structured world of commercial real estate, I noted a concurrent, pregnant pause in investor decision-making followed by a discernible and distinct paradigm shift in commercial property valuation and evaluation.
This isn't the first time I've seen an abrupt change in the demand curve for real estate. In fact, that is how it usually happens -- abruptly. (Obtaining my first license in 1980, I well recall real estate interest rates at 18 percent.) So thinking as a local practitioner, what exactly are today's real estate trends?
Let's start with the residential component. In the post-war era, the single biggest year in housing starts was 1950 with 1,952,000 total units. This illustrious record loomed large for decades, like Bob Beamon's Olympic Long Jump record, until it was finally surpassed in 2004 and 2005 with total U.S. housing starts of 1,955,800 and 2,068,300 units, respectively. More recently, housing starts have fallen back from this breakneck pace to an annualized rate of 1.46 million in October 2006; hardly a disaster. This pace is similar to the period from 1997 through 2000. (For those of us in the older crowd, the slowest year in living memory for housing starts was 1991, which had 948,800 total new starts nationwide.) In 2006, the nationwide total inventory for all housing units is approaching 125 million units of supply for 117 million households. Just replacing obsolescent or otherwise dilapidated housing units requires a new construction pace in excess of 1 million units per year.
Commercial construction (private/nonresidential), on the other hand, has not shown the same volatility as the residential sector. Although certainly subject to national economic trends, commercial construction has grown consistently from $109 billion in 1980 to an annualized $294 billion in 2006. (The only downturns being relatively modest on a percentage basis and generally mimicking the broader economy.) A surge to $275 billion in 2001 was followed by a tempered annual pace of $235 billion for the next three years and a new push to $256 billion beginning in 2005.
Consequently, the best way to track and anticipate changes in commercial property markets is to track the broader economic influences. The most concise, comprehensive and readily interpretable publication that I have found on this topic is published monthly by the Federal Reserve and is called "National Economic Trends." (It can be found online at www.research.stlouisfed.org.) Reviewing the November 2006 economic indicators reveals no evidence of impending doom. However, I recommend keeping a close eye on real change in private inventories, private fixed investment and employment percentage change from the previous year.
Locally, we have been barraged with tragic interpretations of the housing market. So how do the local commercial market trends compare?
According to CoStar, the total investment sale transactions for office buildings has declined from a high in 2004 of 274 transactions to 213 total transactions in 2005 and is proceeding at an annualized pace of 212 transactions in 2006. The average price per square foot of $220 for office buildings in 2004 climbed to $265 in 2005 and is $279 per square foot in 2006. Only the last two months shows any evidence of market softness, with the price per foot dipping back to $249 and cap rates modestly on the rise to an average of 6.46 percent. (Local cap rates for office buildings fell from 8.21 percent in 2003 to 7.22 percent in 2004, 6.68 percent in 2005 and finally bottomed out at 6.06 percent in 2006 before climbing back to 6.46 percent in the last 60 days.)
Likewise, the industrial building sales transactions peaked at 359 in 2004, declined to 297 transactions in 2005 and have continued at an annualized rate of 266 transactions in 2006. The average price per square foot was $89 in 2004, $100 in 2005 and $112 in 2006, year to date, for industrial sales transactions. Cap rates averaged 8.36 percent in 2003, 7.52 percent in 2004, 6.73 percent in 2005 and bottomed out at 6.26 percent in 2006 before increasing modestly to 6.29 percent in the last 60 days.
So whenever a blue haired, beloved and esteemed senior colleague takes the floor and begins to prognosticate that the end for commercial real estate is near, feel free to gently point out to him that he needs to reconsider his erudite position. (This sort of curmudgeon gloom-and-doom nay saying is an informal American tradition that I have observed my entire life. I think it finds its origin in the Victorian Era and the failed policies that hastened the decline of the British Empire.)
By the way, anyone born in the 1940s or 50s, myself included, has enjoyed an ever increasing standard of living, a notable increase in life expectancy and a continuous stream of technological, medical and creature comfort perks of every sort. Compared to our grandparents, today's newly wise old owls have lived like marshmallows lying in a bed of cotton balls.
So a word of advice to all the young or otherwise impressionable: Take heart -- ignore the doomsayer.
There is much good work to be done, as these are the best of times.
-- Eric Thies
2007 Commercial Realtors Association San Diego President