Square Feet | Spotlight: A Cloudy Forecast For Commercial Market

MANY commercial real estate players may be ready to turn the page on 2007, in light of the continuing credit crisis and weakening economy. But they may not see a major turnaround throughout most of the country during the new year, according to one year-end industry report.

1345 Avenue of the Americas.

Uncertainty and challenges characterize 2008, with greater downside risk than real estate markets have faced in close to two decades, concluded the Emerging Trends in Real Estate report by PricewaterhouseCoopers and the Urban Land Institute, which interviewed more than 600 developers, services firms and investors over the summer.

The 29th annual survey, which was released last month, reflected the confusion that engulfed the industry as problems with mortgages were unfolding. Even though the commercial sector was faring better than housing, the biggest concerns for the respondents were economic: job growth, construction costs, interest rate changes, income and wage growth, and inflation. And not surprisingly, 78 percent said they expected underwriting standards for commercial and multifamily mortgages to be more stringent in 2008, compared with 70 percent surveyed last year and just 37 percent in 2005.

More recent indicators underscore the concern, as the problems plaguing the residential market have spread to the commercial sector and the broader economy. In late November, Moodys Investors Service reported that commercial property values nationwide declined by 1.2 percent in September.

But despite the unease, there is still optimism out there, said Susan Smith, a manager in PricewaterhouseCoopers Real Estate Business Advisory Services group in New York and an adviser on the report. There are opportunities across all sectors, she said.

Although the overall commercial real estate market is likely to soften, the respondents said they expected certain regions to outperform others. The so-called global gateway cities like New York, Washington, San Francisco, Los Angeles and Boston have become magnets for employers, residents and investors, according to the report. Especially during times of uncertainty, this is where investors want to be, Ms. Smith said.

New York City still reigns in real estate. Its a tale of two worlds — New York and everything else, as one respondent put it.

Indeed, Class A office space — in the newest and best-quality buildings — in highly coveted areas like Midtown and downtown Manhattan continue to sell and lease for record prices, while vacancy rates are hovering around 5 percent, compared with 10 percent nationwide.

Maria Sicola, the executive managing director of research at Cushman & Wakefield, said that she expected Midtown Manhattan office rents to continue to rise by 5 to 10 percent in 2008. That is less than half the rate of this years 30 percent growth. But she warns that rents generally lag other economic indicators by six months or more, so New York could still experience a flattening of rental rates, especially if the economy deteriorates.

In the third quarter of this year, significant office leases were signed, including Alliance Bernsteins lease of 150,581 square feet of space at 1345 Avenue of the Americas and America Onlines lease of 144,404 square feet at 770 Broadway, according to Cushman & Wakefield. And even as the economic outlook clouds, real estate professionals believe there will be strong tenant demand for quality new buildings, such as 11 Times Square, a $400 million tower being developed by SJP Properties, which is expected to be completed in 2009. Asking rents are around $100 a square foot.

While New York came in first in the survey by PwC and the Urban Land Institute, it wasnt the only standout. San Francisco, which is having a resurgence in its high-tech industry, and Seattle tied for second place among the respondents.

Seattle is really coming into its own, Ms. Smith said.

Seattle today has a broad range of employers in addition to large corporations like Microsoft and Boeing, and the city benefits from its proximity to the Pacific Rim shipping routes. Growth controls and geographic boundaries have led to higher-density, mixed-use developments, which are also helping to create vibrant downtown neighborhoods. Survey respondents ranked Seattle at the top for multifamily, industrial, hotel and retail opportunities.

Survey respondents also expected Bostons apartment rental market to remain strong, despite significant new supply coming onto the market. The city has been regaining some of the momentum it lost after a technology downturn early in the decade. Washington, Los Angeles, Honolulu, Austin, Tex., Raleigh/Durham, N.C., and Portland, Ore., were among the other top cities cited by respondents. At the bottom of the list were Detroit, New Orleans, Cleveland, Pittsburgh, Cincinnati and Columbus, Ohio. Respondents said they lacked global cachet and quality of life and continued to lose traditional manufacturing jobs. The report also said that investors tended to back away from second- and third-tier cities in a downturn.

After a recent frenzy of hotel, retail and office development, the emphasis in 2008 may turn to the less glamorous but steady industrial sector, which includes warehouses and distribution centers.

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