Starboard Commercial Real Estate

Hans Hansson | January 10, 2006

This past year was a very good one for commercial real estate. Commercial property sales outpaced supply. Office leasing rates showed real gains for the first time in five years as vacancy rates continued to drop. Retail shopping centers were hot acquisitions. Warehouse space saw historically low levels of vacancy in most core U.S. warehousing markets. Whether you were a real estate broker, investor, or developer or an institutional owner, you had a very happy 2005.

What about 2006? What factors that made 2005 so successful will continue or change in the new year?

One contributor to the hot commercial real estate market was the boom in urban condo conversations. Condo developers purchased office and warehouse buildings and converted them to residential condos or leveled them to build condos from the ground up. With a slower residential sales market on the horizon, the condo market will slow down dramatically or halt altogether. In San Francisco, two major property owners recently began talking about moving away from residential properties and building spec office buildings. The condo conversion market may already have seen its day.

Office vacancies recently dipped two to three percentage points in most major markets across the country. San Francisco saw its vacancy rate drop from 14.5% to 12%, with vacancies fewer than 5,000 square feet in the core financial district running under 5%. A number of owners have or are developing strategies to meet this tightening market with smaller spec suites, which are often leased before they are completed. Rental rates are moving up as a result of this tightening. During the dot-com boom, vacancy rates plummeted to less than 2% and rents hit an average of $62 per square foot in San Francisco. Businesses were forced to pay; the scene was no better elsewhere in the Bay Area. Today, however, the absorption is not being fueled by well-funded speculative new businesses but by a mature business foundation. If a business is accustomed to paying $24 per foot and a new space or a renewal will cost $32, a mature business is unlikely to pay for the 25% increase in rental costs when growth projections are closer to 4%. A dramatic increase may force businesses to look at other markets either around the Bay Area or outside the Bay Area to keep rental costs in line with what they can afford.

A situation like this occurred in the 1979-81 cycle, when rental rates hit $32 per square foot with a vacancy rate of less than 5% in San Francisco; rents ran to $40-$50 per square foot in the top Class A buildings. A construction boom started in Concord, Walnut Creek, and other communities around the Bay Area. San Francisco entered the construction scene late in an effort to keep businesses in the city; this led to a very soft office market known as the "see through" building cycle, when many new projects were left empty for years.

I hope you were part of the glorious 2005 commercial real estate market. My guess is that owners and developers will find 2006 to be much slower. Commercial real estate brokers who have enjoyed some good years selling buildings should start thinking about leasing.
Posted 14 years, 2 months ago on January 10, 2006
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