According to the report, buyers should return to the investment market in greater numbers this year as all-cash and low-leverage buyers including institutions, REITs and foreign investors step up with purchases. Nonetheless, transaction volume is expected to fall short of the 2007 record, perhaps by as much as 25 percent. Capitalization rates are likely to increase up to 100 basis points with Class A properties in supply-constrained coastal markets anchoring the low end of that range and Class B and C properties in secondary and tertiary markets at the high end.
Tenants Will Have More Negotiating Leverage with Landlords
The office market, which is tied to job growth, is expected to absorb 36 million square feet in 2008, a cut of nearly half from 2007. At the same time, approximately 55 million square feet of new space is expected to be added to the U.S. office market, increasing the amount of sublease space and pushing office vacancy up a slim 20 basis points to 13.2 percent over the course of the year.
"To put this forecast in perspective, vacancy increased at the rate of 100 basis points per quarter during the recession year of 2001 and again in 2002. So a gain of 20 basis points in a year when the economy floats just above recession and the supply pipeline is poised to accelerate would qualify as a reasonably optimistic outlook," Bach said.
The forecast calls for Class A asking rental rates to increase 3 percent for CBD space and 2 percent for suburban space in 2008 and notes that effective rates will be under pressure as landlords begin to dangle more concessions to fill their buildings. Markets likely to hold up well as the economy scrapes by in 2008 and despite likely layoffs in the financial services sector are Seattle, the Bay Area near San Francisco, Los Angeles County, the Mountain region, including Denver and Salt Lake City, Texas, the Carolinas, Washington, D.C., Manhattan and Boston.
Bach noted that while the biggest downside risk to the office market is a recession, the possibility exists that the current credit squeeze could be confined to Wall Street, allowing Main Street to move ahead relatively unscathed.
Given these market dynamics, the West Coast will be at the top of investors' buy lists for office assets, according to Grubb & Ellis' Investment Opportunity Monitor, a propriety market ranking in which Grubb & Ellis annually measures 53 office, retail and apartment markets and 51 industrial markets against 13 to 15 criteria important to the performance of real estate investments. Half of the top 10 most promising office investment markets on this year's list are on the West Coast, and half are scattered in other regions. Only the Midwest doesn't place in the top 10 list. Los Angeles County took the No. 1 spot this year, followed by Houston and Washington, D.C. Both Los Angeles Country and the Washington, D.C. region offer solid job growth prospects combined with high barriers to entry, while Houston's long-term economic prospects boosted its ranking. Denver, Seattle, Philadelphia, Oakland, Calif., Portland, Ore., Raleigh/Durham, N.C. and San Francisco rounded out the list.
Industrial Market Positioned to Weather Slower Economic Growth
Perched at an equilibrium point between supply and demand, the industrial market is in a good position to weather the slower economic conditions expected in 2008. Although the industrial construction pipeline takes less time to empty out than other property types, space under construction was at a cyclical peak at year-end 2007 which is expected to push vacancy modestly higher, particularly in the first half of 2008. Expect vacancy to end 2008 at 7.8 percent, a modest increase of 20 basis points from year-end 2007. The forecast is based on expectations of net absorption of 120 million square feet in 2008, down 14 percent from 2007.
"If the economy remains slow as expected over the next few quarters, it could temporarily boost demand for warehouse space because importers and manufacturers will need to store their excess inventories until sales catch up," Bach noted.
A combination of continuing demand, moderately tight market conditions and new construction charging premium rental rates should be enough to push the average asking rate for available warehouse/distribution space up 2 percent. Asking rates are expected to increase by 10 percent or more in just two markets -- San Jose and Oakland/East Bay, Calif., -- compared with 15 markets in 2007. Expect the following markets to post gains of 5 to 10 percent: Houston, Memphis, Kansas City, Mo., California's Inland Empire, Jacksonville, Fla., and Raleigh/Durham, N.C. In contrast, asking rates are expected to decline slightly in Cincinnati, St. Louis, Sacramento, Calif., Nashville, Tenn., Detroit and Atlanta.
Fuel costs, infrastructure issues and the overall economy will drive the logistics markets in 2008 and beyond, and are fueling the growth of Atlanta, Dallas, Memphis, Chicago and Columbus, Ohio as key logistics hubs.
For the second consecutive year, the logistics business is driving demand for space in Grubb & Ellis' Investment Opportunity Monitor's 2008 rankings. Los Angeles retained its top spot on the list, featuring proximity to the busiest ports in the U.S., negligible vacant space and little developable land. Demand is being diverted to the Inland Empire market 75 miles east, which ranked No. 4 on the list, and to sixth ranked Phoenix. Growing inland distribution hubs Atlanta (No. 3), Dallas (No. 8) and Chicago (No. 9) ranked in the top 10 as did Houston (No. 2), Oakland, Calif. (No. 5), Miami (No. 6) and Seattle (No. 10), which all have port facilities.
Will Consumers Stop Spending in 2008?
"With prospects for the economy looking weak, particularly in the first half of 2008, leasing activity will face headwinds as retailers trim their expansion plans and look more critically at underperforming stores," Bach said.
Space completions are expected to increase slightly in 2008 to 35 million square feet from 33 million square feet in 2007. Since a majority of this space is either built-to-suit or pre-leased with anchor tenants, vacancy is expected to change very little. Markets offering the strongest defenses against faltering consumer confidence include Texas, the Southeast (particularly the Carolinas), the Pacific Northwest, the Bay Area in Northern California and the Mountain States.
Bach said growth in 2008 will come from financial institutions looking to increase their retail presence, massage and day spa chains, fitness centers and retailers catering to the ethnic market. He also noted that lifestyle and mixed-use centers will continue to be popular, including downtown projects and districts built around sports facilities.
According to Grubb & Ellis' Investment Opportunity Monitor, no retail market is immune to the slowdown of the housing market, but some offer more protection due to stronger growth prospects. The top markets for retail investors are scattered across the U.S., led by Washington, D.C. and Los Angeles. Dallas/Fort Worth, Atlanta and Houston all offering demographic and economic growth prospects rounded out the top five markets. Philadelphia (No. 6) and Chicago's (No. 9) stable economies placed them higher in the ranking. California's Orange County and San Diego tied for seventh place, both offering good longer term growth prospects despite the current housing market chill. Portland, Ore., with its urban growth boundary and superior planning controls, ranked 10th.
Strong Fundamentals Seen for Multi Housing
The ongoing downturn in the housing market will continue to be a boon for the multi housing rental market in 2008 as more households choose or are forced to rent. Some markets and submarkets that have been overbuilt with condos or experienced high levels of foreclosures will see an increase in "shadow" supply.
Of the top 10 apartment markets in Grubb & Ellis' Investment Opportunity Monitor, six are in California and three are on the East Coast. These markets offer barriers to entry, solid economic prospects and high home prices that, although they are slipping in most areas, will remain higher than inland markets. At No. 6, Dallas/Fort Worth's robust job growth and population growth outweigh its low barriers to entry. Ranked in order, the top five markets are Los Angeles, Washington, D.C., Orange County, Calif., San Diego and Oakland/East Bay, Calif. Dallas/Fort Worth was followed by Northern and Central New Jersey, San Jose, Calif., New York and San Francisco.
