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Commercial real estate is like a three-legged stool. It is basically composed of sales, refinancing and leasing. At the Virginia Commonwealth University Real Estate Trends Conference on Oct. 13, the speakers emphasized the sales and refinancing side of the commercial market. However, the leasing side, in my opinion, wasn’t addressed, and it needs to be.
At the International Council of Shopping Center Virginia meeting in September, there was an interesting session on “Today’s Capital Markets.” That of course refers primarily to the sales and refinancing legs of the business. There was a comment made by John Levy, the president of Richmond-based John B. Levy & Co. that caught my attention.
Levy indicated that commercial rental rates wouldn’t begin to climb again until six to 10 quarters after the economy bottomed out. I contacted John to ask what he meant, and he said “bottom out” meant when the gross domestic product bottomed out. To me, that means when the economy begins to grow again. So let’s assume that the recession has officially ended, as many economists are saying. That means, if John is correct, commercial rental rates won’t start to recover until sometime between the second quarter of 2011 and the third quarter of 2012.
If you are a tenant who has looked for retail, office or industrial space since last year, you have noticed that rental rates have decreased. Landlords have been willing to make concessions to retain tenants, to provide larger tenant improvement allowances for new tenants and to offer lower rental rates for new tenants. This has held true to one extent or another regardless of whether the space is being rented for industrial, office or retail use. It’s simply supply and demand.
Vacancy rates around Richmond for industrial space, according to the Co-Star Group, have increased from 7.4 percent to 11.7 percent overall from the third quarter of 2008 to the third quarter of 2009. Office space vacancy has increased overall from 10.7 percent to 11.7 percent for class A space, from 8.9 percent to 11 percent for class B space and from 5.3 percent to 6.8 percent for class C space overall. In some areas, such as Innsbrook, the vacancy rates are much higher. For retail space, the overall vacancy rate has increased from 5.8 percent to 7 percent.
The actual dollar-per-square-foot decreases in rent are more difficult to quantify because various types of spaces and locations determine the percentage decrease, but suffice it to say that there are very few properties that aren’t affected by the depth of the recession.
For example, retail rental rates in the Short Pump area have decreased between 20 and 30 percent in the past year. That’s from record highs for the area that were pushing $40 per square foot. The rest of the marketplace is closer to an 11 percent decrease.
It’s probably tempting for tenants to think they can time the market. And some will do it successfully and lock in savings. But “market timing” has risks.
Remember that John Levy’s forecast might prove to be correct or might prove to be wrong. A few quarters in either direction could make a big difference in this cycle.
But unless jobs are created, excess capacity will exist for all types of commercial real estate and the “tenant market” will persist.
Brian Glass is a senior vice president at the commercial brokerage Grubb & Ellis | Harrison & Bates. The views expressed here are his and do not represent those of his firm or Richmond BizSense.
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