The commercial real estate market throughout the United States is generally very healthy. Unlike the residential market for one to four unit residential properties which has softened in many areas of the country, the commercial market is characterized by strong demand and, in many areas, limited supply. There continues to be a good supply of mortgage funds and demand from buyers from individuals to major institutional investors who, in many cases, will bid aggressively for good property.
Reasons for this strong demand generally include the healthy state of the U.S. economy, the fact that in most areas of the country there has been very little overbuilding so vacancy rates are within normal ranges, and the fact that there is a ready supply of money for both equity and debt for commercial real estate. The economy continues to perform well with inflation at 3.6% for the first half of 2006, unemployment having just fallen to 4.4% in September and the economy growing at a 4.1% rate at the end of the second quarter of 2006.Â
While the Federal Funds Rate increased steadily from 1% in June 2003 to 5.25% in June 2006 the Fed has not raised it since then and some experts believe that the Fed may even lower it later this year or early in 2007 provided inflation does not increase in the next month or so. Interest rates for commercial mortgages have risen following the increases in the Federal Funds Rate but are still primarily in the range of 6% to 8% for a 75% to 80% loan. Capitalization rates have not risen quite as fast as interest rates because of the high demand for commercial property and some investors are delaying their purchasing decisions waiting for capitalization rates to catch up with interest rates. Whether rates will increase depends in large part on the level of continued strong demand at current prices. Despite this cap rate compression we think that there are good deals in many of the U.S. markets and that with interest rates at their historically low levels investors should continue to look for properties to purchase.
One sector of commercial real estate which is becoming more attractive after having been avoided by many investors in recent years is the office sector. Since the 1990’s the market has been absorbing an oversupply of office space and in many metropolitan areas this inventory has diminished sufficiently that developers are proposing to build or are currently building new office buildings. This is a good time for investors to consider office investments while closely examining the market demand, vacancy rates, proposed new competition and other pertinent factors in their specific areas.
The other major sectors of the commercial real estate market – apartments, retail and industrial are all very healthy with vacancy rates at reasonable levels and with rents and expenses generally keeping up with inflation. As is usually the case, in any particular market the characteristics (rents, vacancy rates, capitalization rates, expense ratios, buyer demand, etc.) of the individual sectors may vary with some sectors being more attractive than others.
In summary, most of the commercial market is very healthy now and may, for some investors, be an attractive alternative to the one to four unit residential markets which are undergoing some significant changes now.
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