According to the report, the volume of investment transactions is likely to stabilize in 2007 following five consecutive years of gains, but it will stabilize at a high level. If interest rates and cap rates remain well-behaved in 2007, as expected, then the income component of the total return equation will once again eclipse the appreciation component, and real estate will return to its historic role as a solid income-producing investment with a small appreciation kicker.
Landlords Will Have More Negotiating Leverage with Tenants
Businesses will use their record profits to add staff and lease more space in 2007. About one-quarter of the expected 100,000 new payroll jobs per month in 2007 will be located in office buildings, generating absorption totaling approximately 55 to 60 million square feet in 2007. This growth will outpace completions by at least 10 million square feet, bringing the vacancy rate to 13.2 percent nationwide at year-end 2007. The anticipated 0.4 percentage point decline from 13.6 percent at year-end 2006 will be the lowest decline since the market recovery began in 2004.
However, as markets tighten further in 2007, landlords in a greater number of markets, submarkets and individual properties will capture more negotiating leverage from tenants. Five CBD markets -- San Francisco, Seattle, Miami, San Jose, Calif., and New York Midtown -- are expected to post double-digit increases in Class A asking rental rates in the coming year: Twenty CBD markets will see Class A rates rise by 5 percent or more in 2007, compared with nine CBD markets in 2006. Not all landlords will be looking at rent gains in 2007, however. Class A rental rates are likely to stay flat or recede slightly in a number of CBD markets, including Cincinnati, Omaha, Neb., Atlanta, Pittsburgh, San Antonio, Detroit and Wilmington, Del.
"The future of the office market looks bright," Bach said. "Business capital spending and the expanding global economy will power demand for space even if the U.S. economy remains sluggish in the first half of 2007 as expected."
Given these market dynamics, office assets have rotated to the top of investors' buy lists. Washington, D.C., tops the buy list, barely edging out Los Angeles and Las Vegas, according to Grubb & Ellis' Investment Opportunity Monitor, a propriety market ranking in which Grubb & Ellis annually measures 52 office, industrial, retail and apartment markets against 13- to 16 criteria important to the performance of real estate investments. Despite topping this year's list, Bach cautioned that the entire Washington, D.C., metropolitan market is seeing a tremendous amount of construction activity and certain submarkets could be impacted by the Defense Department's base realignment and closure program. Dallas/Fort Worth, Phoenix and Houston also make the list by virtue of surging population and employment growth, healthy expected rent growth in 2007 and still reasonable cap rates. Rounding out the top 10 are Seattle, Orange County, Calif., Orlando, Fla., and Portland, Ore.
Imports to Sustain Large Distribution Centers in Key Logistics Markets
The expanding economy will keep supply chains humming in 2007, generating demand for all types of industrial space. According to Grubb & Ellis, demand for space will fall modestly in 2007 to 140 million square feet, from 170 million absorbed in 2006.
If the weak housing market dampens consumer spending in 2007, retailer demand for distribution centers could be impacted. Bach also noted that the weak housing market could have a more direct impact on demand for industrial space in 2007 as construction companies and contractors that occupy industrial space downsize and return some of the space to the market.
Developers are expected to add 150 million square feet of new industrial space in 2007. Grubb & Ellis expects the vacancy rate to fall by 0.1 percentage point to 7.6 percent by year-end 2007, indicating that the overall market will be in equilibrium through much of the year. The average asking rent for both warehouse/distribution space and R&D/flex space is expected to increase by 3 percent in 2007, though this will vary by market. Grubb & Ellis expects nine markets to post double-digit increases in asking rates for warehouse/distribution space, led by San Jose, Miami, Oakland/East Bay, Calif., Dallas/Fort Worth and Austin, Texas. A handful of other markets, including Seattle, Grand Rapids, Mich., Los Angeles' Inland Empire and Atlanta can expect asking rates to be mostly flat.
Bach predicts strong demand for industrial properties of all types for years to come. Development of large distribution centers is likely to spread further away from major metropolitan areas as developers and users search for cheaper land and lower costs, respectively. It is also likely that markets not currently regarded as major logistics hubs, such as Kansas City, Nashville and Richmond, Va. - will see construction of larger and more sophisticated distribution properties.
The logistics business is driving demand for space in Grubb & Ellis' Investment Opportunity Monitor's 2007 rankings. Tenants, owner-users and investors are paying up for space in top-ranked Los Angeles, which features proximity to the ports of Los Angeles and Long Beach, the lowest industrial vacancy rate in the U.S., projected double-digit rent growth in 2007 and a critical shortage of land. The robust industrial markets in Houston and Dallas/Fort Worth occupy the second and third slots on the list. Other markets making the top 10 list of industrial markets offer proximity to seaports or inland ports including Miami/Dade County, Oakland/East Bay, Calif., Chicago and northern and central New Jersey. Phoenix and Las Vegas, both facing constraints in their supplies of developable industrial land, are ranked fifth and 10th, respectively.
Retail Market Begins 2007 Murky
The outlook for the U.S. retail market is murkier at year-end 2006 than a year ago, when the housing slump was just getting underway. The housing market slowdown will have major implications for retailers on two fronts in 2007. First, homeowners will be less able to tap into their home equity via cash-back mortgage refinancing and home equity loans. Second, retail development targeting new residential neighborhoods may be delayed until home construction and sales pick up. However, Bach, adds "never underestimate American consumers. If they can, they will find a way to keep spending."
Grubb & Ellis predicts that retail market will remain in equilibrium with slightly lower construction and absorption.
According to Grubb & Ellis' Investment Opportunity Monitor, strong demographics are key to identifying retail markets that will perform well for investors. Washington, D.C. tops the list, followed by Dallas/Fort Worth, Los Angeles, Houston and Las Vegas. The D.C. market has one of the highest median incomes in the U.S. and one of the fastest growing median incomes over the next five years. Dallas and Houston are adding population and jobs at a rapid rate, and their relatively healthier housing markets will create opportunities for developers and investors over the next five years. Rounding out the top 10 list are: Atlanta, Chicago, Riverside/San Bernardino, Calif., San Diego and Phoenix.
Strong Fundamentals Seen for Multi Housing
The ongoing downturn in the housing market will be a boon for the multi housing rental market in 2007 as households continue to rent in hopes that home sales prices will fall further. Absorption should increase moderately, while new construction should keep the vacancy rate steady. Landlords can look forward to a moderate rise in rental rates with the greatest risk being "re-partments" - stalled condo conversion projects that are returning to the rental inventory.
Of the top 10 apartment markets in Grubb & Ellis' Investment Opportunity Monitor, nine are in the West and five are in California. These markets benefit from a combination of factors, including strong population growth, a high percentage of the population in the age groups most likely to rent apartments, robust job creation and high housing costs. The top multi housing markets are: Riverside/San Bernardino, Calif., Los Angeles County, Washington, D.C., Dallas/Fort Worth, Phoenix, Sacramento, Calif., Houston, Las Vegas, Orange County, Calif., and San Diego.
