Interesting trends in office vacancy rates

by Brad Houle, CFA
Executive Vice President
Ferguson Wellman,
A leading Oregon financial firm

Market Summary

January 27th –  The equity markets were higher by about 1.3 percent compared to last week as investors absorbed fourth quarter earnings and reacted to the changes in Washington. Interest rates were higher, with the 10-year Treasury climbing in yield from 2.39 percent to 2.49 percent. The Dow Jones Industrial Average crossed 20,000 this week but the real story is how long it took to get here. It was March 1999 when we crossed 10,000 and 18 years later the market has finally doubled. While new milestones in market averages are always interesting to note, ultimately, what really matters for stocks is earnings and how much investors are willing to pay for earnings.

Commercial Real Estate as an Opportunity

This week, investment team members from Ferguson Wellman and Versus Capital met to discuss the national and international view of the commercial real estate markets. Versus Capital manages a real estate income fund designed to serve as a core real estate holding. Versus Capital has expertise in office, apartment, retail and industrial real estate property types. While those living in the Pacific Northwest can see physical evidence of commercial construction by counting the number of high-rise cranes peppering the skyline, Versus Capital presented important opportunities further abroad in the U.S.

U.S. property market fundamentals continue to improve [1]:

– The national average office vacancy rate fell 50 basis points over the prior four quarters and has settled at 10.5 percent, the lowest level since the first quarter of 2008

– The national average industrial vacancy rate declined to 6.3 percent, down 70 basis points over the prior four quarters; which is now at the lowest level since the middle of 2000

– The national average apartment vacancy rate increased slightly to 5.2 percent, up 10 basis points over the prior four quarters; and has remained between 3.8 percent and 5.2 percent since the middle of 2011

– The national average retail vacancy rate declined to 5.4 percent, down 50 basis points over the prior four quarters; and is at its lowest level since the beginning of 2006

Commercial real estate is not an undiscovered asset class in this low return environment. As investors are attracted to this consistent cash flow that stable high quality properties can provide. Despite the recent increase in bond yields, all types of investors from pension funds to individual investors are starved for yield, and the road to commercial real estate is wide open.

Historically, the two factors that could cause a problem for commercial real estate is an oversupply of properties or an economic downturn that disrupts demand for property. New supply of commercial real estate is quantified by looking at the new construction as a percentage of the existing stock of commercial property. Presently, the rate of new supply has been running 0.6 percent to 0.8 percent as compared to the long-term average which is closer to 1.8 percent. This statistic suggests that nationwide, the new supply of commercial property is fairly muted. One of the primary reasons for this is the tightness in the availability of financing due to increased financial company regulation.

This muted supply, coupled with our forecast for sustained if not increasing economic growth, suggests that investors should be able to enjoy cash flow generated from real estate for the present time.

Takeaways

While not an undiscovered asset class, commercial real estate still offers attractive cash flow opportunities for investors

[1] Versus Capital