Article by Randy Drummer, CoStar Group, January 25, 2012

Office space absorption doubled during 2011 as the office-using job base expanded and vacancies declined across nearly two-thirds of U.S. submarkets, CoStar Group reported this week in its Year-End 2011 Office Review & Outlook. The report presented to CoStar clients found that positive momentum in office fundamentals and the continued absence of new construction is expected to result in higher rents for building owners over the next few years.

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With the construction pipeline all but shut down and reduced rents prompting many tenants to trade up for better or more efficient space, the U.S. office market absorbed a strong 19 million square feet in the third quarter, according to data presented this week at CoStar Group’s Third-Quarter 2011 Office Review & Outlook.

The leasing activity helped lower the national office vacancy rate slightly to about 13.1% — down nearly a half percentage point since hitting its peak a year ago. Should leasing activity remain at the level seen this past quarter, it would set the stage for future rent increases, since little to no new supply is being added. CoStar’s analysis found office rents firming or already trending up in some key metros, and more increases are expected to spread across the country by 2013.

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Prologis, the world’s largest developer and owner of warehouses, expects the recovery in logistics real estate will accelerate through 2012, with an upswing in production, trade and inventories translating into nearly 400 million square feet of positive absorption globally next year.

Even taking into account the economic soft patch earlier this year caused by rising oil and commodities prices, the debt crises in Europe and the U.S., and the natural disasters in Japan, the U.S. recorded the strongest second-quarter net absorption of logistics space in four years, according to the San Francisco-based global firm.

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25-year-old real-estate investment trust, which has sparked some criticism for its strong appetite for acquisitions, has agreed to buy New Orleans’s tallest skyscraper for $107 million, according to people familiar with the property.

CommonWealth REIT, of Newton, Mass., is buying the 51-story office building named One Shell Square from MetLife Inc., the people said. CommonWealth and MetLife declined to comment on the deal.

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Numerous indications over the past few weeks point to an easing of investment capital for real estate deals. Life insurers have become more active lenders; new CMBS offerings are hitting the street; syndicators are starting to assemble new CDO offerings; and bank loan officers are reporting the first easing of lending standards in years.

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First quarter commercial real estate market fundamentals in 2011 continued their improvement over 2010. This will come as no surprise to anyone who understands that commercial real estate demand is derived from activity in the overall economy. As the economy goes, so go commercial real estate fundamentals.

When looking at the change in economic indicators outlined below, the continued improvement makes sense. Consider the following:

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Tightening Supply In Suburban Markets Will Eventually Benefit Owners and REITs as Tenants Trade Up For Higher-Quality Space at Attractive Rates

Picking up where they left off last year, U.S. equity REITs continued to post strong returns in the first quarter of 2011, outperforming broader market indices despite a late-quarter slowdown that softened returns on investment trust stocks in March, according to new figures from NAREIT.

The gains appear to reflect investor expectations that market fundamentals will continue to improve across all sectors of commercial real estate — including an anticipated deepening of the nascent office sector recovery to include suburban and some second- and third-tier office markets assets.

The FTSE NAREIT All Equity REITs Index, which covers 120 investment trusts with an implied market capitalization of $417.7 billion, rose 7.50% in the first quarter, easily outpacing the Standard & Poor’s 500, which rose at 5.92% in the first three months.

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Blockbuster transaction volume in December helped to push U.S. commercial real estate sales to $115 billion for 2010, up 109% from $54.6 billion in 2009, according to preliminary results from Real Capital Analytics. December’s volume of more than $21 billion was the highest sum for a single month’s trading since the end of 2007.

“I think the recovery in transaction activity has snuck up on everyone,” says Dan Fasulo, managing director at Real Capital Analytics. The New York-based research company will publish its findings on December transactions later this month in its Capital Trends Monthly report.

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Investors searching for distressed big-box deals are facing competition from an unlikely source — retailers. Large tenants including Wal-Mart, Target, Kohls Department Stores and others have become aggressive bidders in the market for vacant big boxes. The retailers are buying distressed space from owners or banks, often at prices that are 20% to 30% higher than real estate investors are willing to pay.

As a result, retailers have become large players in the single-tenant market.

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Reversing two months of increasing commercial real estate prices, all three of CoStar’s “headline” Commercial Repeat-Sale Indices decreased in October, continuing the recent see-saw performance of commercial real estate pricing, according to CoStar Group’s newly released Commercial Repeat-Sale Indices (CCRSI).

CoStar’s national all property type index declined 3.88% during October, giving back its 3.07% gain in September. The index representing all commercial properties and the broadest industry measure of commercial real estate transaction pricing, slipped to its lowest point since the index peaked in February of 2008. While still decreasing, the rate decline has begun to slow considerably. Since June of 2009 the rate decline has been reduced by half.

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