Good News Friday - September 25, 2009

What about Real Estate?

The economic news has been mostly encouraging lately. Even the labor market, a lagging indicator, is showing tentative signs of a rebound as initial claims for unemployment benefits fell for a third consecutive week. A number of analysts contend that the recession has ended, although we won’t know for sure until the National Bureau of Economic Research, a nonprofit organization charged with assigning dates to business cycles, makes the call sometime next year. If you think back to the financial chaos of last September and the mixture of fear and gloom that settled over global markets for the next six months, it certainly didn’t seem like the recession would end this soon.

For commercial real estate, perhaps the last industry to join the recovery, recent news hasn’t been so good. Both the investment and leasing markets appear to be stuck in molasses. For a more optimistic outlook, it helps to take a long-term view backward and forward.

• In the early 1990s, there was a feeling that commercial real estate was a permanently damaged asset class with market fundamentals unlikely to recover for a very long time. The market had been badly overbuilt, and respected analysts said that it would not need another square foot of space until after the millennium. There was a further sense at the time that computer and networking technology would suppress the need for, and value of, office, retail and even industrial space. That view proved to be far too pessimistic as most markets were on the road to recovery by the mid-1990s. Today there appears to be more confidence that the asset class will embark on a recovery within a year and feel noticeably stronger in the 2011-2012 time frame. For evidence of this relative optimism, look no further than the growing reservoir of capital being raised to target distressed assets. There has even been talk of too much capital, which could serve to put a floor under prices.
• Looking ahead, commercial real estate could be positioned to reprise its role as an inflation hedge, a role it last performed in the early 1980s – see chart on right. Inflation is unlikely to be a problem for the next couple of years, but the growing deficit, weak dollar and a potential reduction in the willingness of investors to buy U.S. government debt could spur a bout of inflation later on as the recovering economy sops up excess capacity in the labor market, factories, housing and commercial properties. This could coincide with a recovery of commercial real estate leasing markets – falling vacancy rates and rising rental rates – which would make the asset class look very attractive to investors. Analysts are divided over the potential for inflation down the road, but the timing of an outbreak, if one occurs, could favor commercial real estate.

Have a great weekend.

Robert Bach
SVP, Chief Economist
Grubb & Ellis
312.698.6754