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Monday, May 5, 2014

The Commercial Office Market - An Illusion of Recovery, Keith Jurow, May 5, 2014

Investment blogger Doug Short of Advisors Perspectives provides an analysis by Keith Jurow, a real estate analyst, of the commercial real estate market since the Great Recession looked at through the eyes of prospective investment in real estate investment trusts (REITs).  Jurow's conclusion: 
In the latest issue of my Report, I analyzed six other office REITs. I was unable to find even one which offered the possibility of a decent return for investors. As I saw it, they were terribly overpriced with very high P/E ratios. Yet Wall Street has been silent about the serious weakness in office markets outside of Manhattan or San Francisco.
My advice to you: Don't delay in taking action. Office renting will weaken badly over the next 12 – 18 months. The liquidity in suburban and smaller urban office markets will decline and buyers will be much harder to find.
Jurow's analysis views the poor prospects of the commercial office market, in particular, from the perspective of sales prices and volume, which are up from their recession lows, but fall far short of their 2007 highs.  Much of the problem he attributes to new accounting standards that let REITs and banks ignore the reality of the future of commercial office market.  And he highlights how the national averages distort the narrow reality of improvement in only a few "tech-centric" office markets.  And despite its aspirations to tech-centricity, Washington is not one of them as this table of the top 10 CRE markets shows.  Only Manhattan has seen real price growth with Dallas, Houston, and Boston almost keeping pace with inflation since 2007.  Indeed, among this "Top 10," the Washington area market showed the least price improvement over the last year.


Jurow walks through the analyses of several major international CRE companies showing their skepticism about the growth prospects in this market.  Here is what Cassidy-Turley, a major CRE player in the Washington market among others, had to say about "absorption" (the net gain in rented square feet of office space):
Key to Understanding Office Space Absorption
In its What's Hot in Commercial Real Estate report issued last summer, Cassidy Turley emphasized that all of the office space absorbed nationwide since 2010 was in newly-built or newly upgraded properties. These were buildings that had been constructed or rehabbed since 2007.
Around the country, tenants were chasing after these newer office buildings. The vacancy rate for new or upgraded space had been cut in half since 2010. Unfortunately, Cassidy Turley pointed out that the vacancy rate for the vast majority of what it called "traditional space" was languishing at recessionary highs. We are talking about 80,000 office buildings in the US which were more than twenty years old and comprised roughly 60% of the nation's total inventory.
This reality of what was occurring in office markets around the US is completely lost when pundits zero in on the slight decline in the nationwide average office vacancy rate. A small sliver of office markets in a few strong metro markets was where the hot action was. That tells you nothing about the vast majority of office buildings and the desperate search for tenants by their owners.
While Jurow focuses on the weak performance of the office and other commercial RE markets nationally, he doesn't did into the causes of that poor performance very deeply (beyond the accounting tricks mentioned above).  As we have reported extensively in the past, the nature of the office market is changing dramatically as office space per worker plunges from over 300 gross square feet (GSF) to less than 200 GSF per person.  There area three inter-related reasons for this shift:
--Corporations have become extremely cost conscious.
--Corporations are highlighting collaborative work office design, without private offices or even cubicles.
--Corporations are emphasizing telework arrangements that enable work from anywhere.
Still, these tectonic shifts in the office market have not been recognized by Fairfax County, which still uses 300 GSF as sizing value for office space per worker despite universal evidence to the contrary.  The market permitting, the long-term result will be that at least half again as many office workers will be allowed in the county's urban areas (Reston, Tysons, Springfield, etc.) as the current County comprehensive plan anticipates.  The impacts on congestion, transportation infrastructure costs, pollution, etc., have not even been considered.

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