Commercial Real Estate – July 2006

For nearly two years U.S. commercial vacancy rates have declined. Average vacancy rate in 72 major office markets across the country in the second quarter stood at 13.8% compared to 14.2% in the first quarter of 2006.Declining vacancy rate has triggered rent increases of 2% for each of the two quarters of this year—another clear sign of a recovery in the commercial real estate market.

The national aggregate vacancy rate data does not give us an accurate picture of office market recovery, as there are large differences among the different U.S. regions. The differences among the various markets reflect the uneven nature of job growth across the country. (Job growth is the prime driver of commercial space use) Another factor in the current resurgence is that smaller companies have created most of the new job growth and this has been a problem for cities that are dominated by major corporations and not hosts to small and medium sized businesses. Other factors that have influenced commercial development in various regions include business friendly local governments and local or regional limitations on office space construction

A key question about the sustainability of commercial real estate in the U.S is what impact will rising interest rates have on the industry? After all interest rates affect commercial mortgage rates just as they affect home mortgage rates.

The major difference between residential and commercial mortgages is that in the former case buyers are mostly private individuals who are sensitive to rate changes compared to the latter where investors are a diverse group that include institutions such as pension funds that can pay cash and not borrow money.

There is another factor underlying the surge in commercial real estate—- strong international demand for U.S. commercial properties. Australia and Germany are the leaders in the foreign stampede to acquire American properties. Why? There are four cogent reasons: a) declining value of the U.S. dollar relative to Australian dollar and the Euro (Germany) that makes U.S. properties more affordable, b) the pull of the number one economy in the world—the U.S., c) flight to safety- (lower political and economic risks in the U.S. than in Europe and Asia), and d) fair laws and highly developed U.S. financial markets attract institutional investors such as pension funds from Australia and Europe.


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