I’ve been a long time subscriber of The Kiplinger Letter.
It is a terrific resource for gaining an overview of the inter-relationships between domestic and world events. It has become a reliable forecasting tool “for management decision making.”
The June 4th issue touches on how the debt crisis in Europe is having an impact on the recovery of the U.S. commercial real estate market. It states high debt causes less demand for American exports, which slows job growth. Everything ripples back to a weak demand for business real estate. Predictions are that vacancy rates will be averaging nationally towards 20% this year, but dropping slightly into the first quarter of 2011.
When we drill down to the market in Frederick County, Maryland, we find that many sectors of the commercial real estate are impacted by the same global issues. For example in looking at the local office and retail markets, it is clear that these sectors are also experiencing difficult times, but are and will stay significantly below the national averages.
In an interview this week with Terrance W. “Bud” McPherson, an MAI appraiser with McPherson & Associates, Inc., located here in Frederick for over 30 years, he noted that the “office market is struggling, primarily because there are very few new tenants coming into the market. This is due to high unemployment.”
In analyzing the active tenant mix, he says, it breaks down to two active areas: Medical and Federal contractors.
Federal contractors typically do not sign long term leases, due to the tentative nature of their government engagement. The lease term may be one to two years, and these leases are not very “bankable” for new construction, as lenders seek much longer terms. This is one of the key considerations in their willingness to make loans in any market, much less our current economy.
The vacancy rates in Frederick are pretty much on par with the rest of the Washington area market.
While “Flex space” (single story office) is the weakest running close to a 35% vacancy rate, McPherson says that traditional office space (elevator service buildings) is experiencing vacancies at the 15% level. Part of the reason that traditional office is running better than average is that landlords are aggressively working with existing tenants to renegotiate affordable lease rates to incentivize them to stay. He has seen some examples where rates have fallen back to early 2001 levels.
McPherson says that the same is true with the retail market, which is running at a 95% occupancy. Many landlords are working closely with their tenants to avoid vacancies. Another reason for the high occupancy rate is that there is a limited supply of new retail and shopping center real estate development occurring. “The Frederick market is just not overbuilt,” says McPherson.
In a recent report to its members the CoStar Group, a commercial real estate listing service, reported that in the first quarter of this year out of the over 10 million square feet of retail space in Frederick County, only about 1.1% is new construction.
Even along Frederick’s Golden Mile, which has had its retail struggles, McPherson notes that when you factor out the Frederick Town Mall (another story altogether), the rest of the corridor is looking “surprising pretty good” at 92% occupancy.
So while vacancy rates in most office and retail sectors are running well lower than national averages, lease rates are decreasing. While this is much better than empty commercial real estate buildings, it still means that property values are being negatively impacted.
Now, if Europe could just clean up their debt problem and start buying more U.S. goods, we’d have more employment, equating to greater demand for business to expand into cmmercial real estate! Well, that may be part of the answer, but far from all of it.
The good news is that the housing market is stabilizing, which is typically the first sign that the commercial market will eventually follow suit.
On a personal note, the phones are ringing more at MacRo, Ltd. with commercial real estate inquiries. Seems more investors are dusting off their calculators. Always a good sign for brighter days ahead!