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Is Commercial Real Estate Back In Black?

The commercial real estate market has seen a rise in demand and activity as developers grow more comfortable with the nation's economic growth and lenders approve more deals.

But experts say there needs to be greater progress in a few key areas — including more loans to small businesses — before commercial real estate moves into full recovery mode.

Current gains are coming about in baby steps rather than giant strides. Vacancy rates in coming quarters are expected to decline no more than half a percentage point in the office, industrial and retail sectors, according to the National Association of Realtors.

The multifamily housing sector, which already has tight vacancy rates and high prices in many cities, is expected to see a slight rise in rates over the next few quarters.

Still, recent activity at least shows evidence of a fundamentally improving market, analysts say.

"The recovery in commercial real estate has been steadily growing," said George Ratiu, manager of quantitative and commercial research at the National Association of Realtors. "In terms of the volume of deals, we continue to see improvement. And there has clearly been a strong recovery in prices.

One thing driving growth in the commercial sector is a pickup in lending for deals valued at $2.5 million or higher. Ratiu says the availability of capital is "slowly trickling back into market" as national banks and insurance firms loosen their purse strings.

The upshot is that an estimated $294 billion worth of commercial real estate deals of $2.5 million or higher were signed last year. That's more than halfway to the peak of $571 billion established in 2007 and well above the $66 billion recorded in 2009.

Commercial real estate giant Brookfield Office Properties (BPO) has closed on commitments for up to $1 billion in financing on a couple of office towers at Brookfield Place in lower Manhattan, the company said Monday.

The properties are the 2.5-million-square-foot 225 Liberty Street and the 1.8-million-square-foot 250 Vesey Street. They were formerly known as 2 and 4 World Financial Center.

The financing comes from a consortium of banks led by Deutsche Bank (DB), Royal Bank of Canada (RY), Citibank (C), Bank of America (BAC) and Wells Fargo (WFC). The rate Brookfield got is a floating 3.44% for three years with two years of extensions possible.

Jesse Tron, a spokesman with the International Council of Shopping Centers, confirms a rise in financing for retail developments.

"There is capital available now that wasn't there a couple of years ago," he said. "The difference now is that retail centers are reinvesting in current assets rather than building from the ground up.

Smaller Deals

But deals of $2 million or less, which are a big slice of the commercial real estate market, have had "a much harder slog," Ratiu says.

That's partly because these deals are dependent on regional banks, and many of those are still gun-shy about lending money. Meanwhile, growth has also been tempered by continued uncertainty in many parts of the U.S. economy.

While people in high income brackets have seen a recent rise in income thanks to stock market gains, those on the other end of the income scale continue to struggle.

"Those in lower-income brackets are not seeing any growth in their income. Commercial real estate is dependent on the American economy, and with an uneven recovery the market still has a way to go before a full recovery," NAR chief economist Lawrence Yun said in a statement after the Realtors Midyear Legislative Meetings & Trade Expo last month in Washington.

Those issues aside, people in commercial real estate sound much more upbeat about current conditions and future growth than they did a couple of years ago.

The Realtors Expo included a live poll of commercial real estate professionals, most of whom said their local economies are either a little better or showing a major improvement from a year ago.

Yun, who sat on a panel during the expo, noted that overall transaction volume in the commercial real estate market is slowly improving, and that property sales are rising.

While New York tops the list in sales volume, smaller markets such as Seattle and Austin, Texas, have seen strong year-over-year improvements — a sign that large commercial real estate investors have grown more comfortable putting their money in midsize markets.

Smaller metro areas have posted particularly strong gains in the multifamily housing market.

According to second-quarter estimates from the NAR, New Haven, Conn., has the lowest vacancy rate for multifamily, at 2%. New York is next at 2.2%.

Other metro areas with vacancy rates below 3% include Chattanooga, Tenn.; Hartford, Conn.; Minneapolis; Oakland-East Bay, Calif.; Pittsburgh; Portland, Ore.; Rochester and Syracuse, N.Y.; and San Diego and San Jose, Calif.

Historically, 1.5 million new households are formed in the U.S. every year. That figure dropped to 400,000 in the wake of the financial and housing crises. Ratiu expects new household formations to rebound to 1.3 million this year. "For us, that translates into roughly 276,000 new apartment units being absorbed in the market," he said.

Vacancy Rates Improve

Meanwhile, vacancy rates for other commercial real estate continue to improve, albeit slowly.

The NAR surveyed 82 metropolitan areas for its second-quarter estimates. It expects national vacancy rates in the office sector to drop from 15.7% currently to 15.6% a year from now. Washington, D.C., has the lowest current rate at 9.4%.

The national vacancy rate for industrial real estate should drop from 9.4% now to 8.9% a year from now. Orange County, Calif., has the lowest rate at 3.9%, followed by nearby Los Angeles at 4.1%.

"Industrial has had a very swift recovery in large part because U.S. trade has picked up in terms of both exports and imports," Ratiu said. "Demand for warehouses is gaining steam in line with the broader trade trend.

The retail sector should see vacancy rates fall from 10.5% this quarter to 10.2% a year from now.

"Occupancy rates for malls and community centers have been holding steady over the last several quarters, which is a good sign for retail," the ICSC's Tron said.