What Can We Expect From Commercial Leasing Markets in 2011?

by CoyDavidson on December 14, 2010

Research Matters

By: Ross Moore | Chief Economist, Colliers USA

This is the first in a series of 2011 projections which will be distributed over the next week and a half. The first will be our view on the nation’s office, retail and industrial leasing markets. Later this week we will address the investment sales market, and the third and final part in the series will list the likely top markets in 2011.

Leasing Markets Are Anticipated to Surprise on the Upside, But Don’t Expect Landlords to be Dancing in the Streets

The general tenor in the market today is one of skepticism. The consensus is that without a robust upturn in the labor market, leasing markets will remain extremely sluggish. This is a somewhat simplistic outlook, as the decision to lease space is based on more than just yesterday’s headcount, but rather the outlook for sales and the ability to grow revenues in the short and medium term. With the midterm elections behind us, the probable extension of the Bush-era tax cuts, and the various other stimulus measures announced recently, the business community should begin to start thinking about growth and expansion and less about cost cutting and retrenchment. Our view is the economy is not going expand vigorously in 2011, but neither will it fall off a cliff; we believe it will grow between 2.0 and 3.0 percent. Unfortunately this won’t be enough to bring the unemployment rate down significantly, but it is a good backdrop for businesses to expand and take on a modest number of new employees. Unemployment will remain high but that won’t necessarily mean that some businesses won’t thrive. As the economic recovery takes hold, it will become increasingly obvious many of the jobs lost in the Great Recession just aren’t coming back. This generally positive economic outlook should be sufficient to juice the market and push occupancies higher, but owners and investors will still be stuck with more supply than the market ideally needs.

Market Fundamentals Should Look a Lot Better 12 Months From Now

As the chart below demonstrates, vacancy rates across the three main property types are all projected to be lower a year from now. Helping to bring vacancies down is the dearth of new construction that will be hitting market in 2011 with many markets adding no new supply. On the demand side, we see occupancies rising approximately 1.0 percent. This is through the combined effects of a degree of latent demand, improved credit conditions, modest growth in the domestic economy and continued high rates of growth in the global economy. The corporate sector is sitting on record levels of cash, rising profits and sound balance sheets. Prudence is still a word often heard, but 2011 should mark the time when companies open a second office, take an additional floor or take back sublease space that they now feel they need. While office, industrial, and retail markets differ, a combination of rising confidence, low interest rates, further gains in private sector employment, the bottoming in the housing market and perhaps, and most importantly, the last chance to lock into low rental rates, will help push vacancy levels down across all property types. Industrial is almost certainly to lead, followed by office and then retail, but all should improve. Industrial is more directly affected by manufacturing, distribution and global trade, while retail is more a function of employment, wages and access to credit, and office is most sensitive to job growth. All these key demand drivers are expected to improve next year.

How Will This Translate into Rents?

Even though most space markets will tighten in 2011, this is highly unlikely to result in higher lease rates, at least not for the majority of markets. Vacancies are still too high for landlords to start pushing rents higher across the board, but in certain markets, and particularly for tenants with large or unique space requirements, rents may creep up as much as 10 or even 15 percent. With virtually no construction underway in any of the three main property types, large tenants with leases expiring in 2012, 2013 and 2014 could have very few alternatives open to them. Quality premium space will start leading rents higher as early as mid next year. At the other end of the spectrum will be tertiary markets with an abundance of nondescript “commodity” space that may not see any increase and could even go lower as landlords try to entice tenants through price. While real estate market are always stratified, we expect this to be even more so in 2011.

Is This Outlook Way Too Optimistic?

Maybe. There is no way of getting around the fact that the economic recovery could be derailed by a multitude of possible events. The projections above, however, are based on the mostly likely outcome and the information we have at hand. The Federal Reserve in particular, has made it abundantly clear they are going to do everything in their power to keep the economic recovery going until there are definite signs that the economy no longer needs a helping hand from the central bank.  Keep in mind, the U.S is a $14 trillion economy and so even with just 2.0 to 3.0 percent growth, this adds up to a lot of billions! The message to owners and occupiers of commercial and industrial space is: occupancy levels are no longer shrinking and 12 months from now, vacancies will almost certainly be lower and investors will be on their way to growing revenues and expanding their tenant base.

Ross Moore is the Colliers International’s Chief Economist with a focus on providing bottom-up and top-down analysis of commercial real estate markets across the United States. In addition to his North America wide reports, Ross also authors all global research produced by Colliers.

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