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U.S. Commercial Real Estate Market Slowing But Still Strong

Commercial real estate firm Grubb & Ellis says there is an imbalance between investor demand for properties and the supply of properties available for sale. That has driven down rate of return expectations and made it difficult for investors who want to put capital into commercial real estate.

Investors are expecting higher rental rates will boost returns to offset the higher cost of buying properties today. However, rental rates in most markets have just recently leveled out or begun to rise slightly. As construction levels rise, there is a fear that developers will overbuild. Other potential hazards for the commercial market are rising interest rates and a recession, which isn't expected anytime soon.

Capitalization rates are expected to move slightly higher but at a slower pace than interest rates because fundamentals in real estate are improving and there is still a lot of capital looking for a home in real estate.

Here's how the market is shaping up in the apartments, office, retail, and industrial sectors of commercial real estate:

• Apartments
  For investors, Riverside, Calif. is the leader because of an explosion in population growth and very expensive except when compared to coastal markets of Orange, San Diego and Los Angeles counties. Apart from Las Vegas, Phoenix and Washington, D.C., the top apartment markets include Broward County, Fla., Sacramento, Calif., and Central and Northern New Jersey.

• Office
  Phoenix takes the top spot as Class A rental rates are forecast to jump 15% this year. And half of the top 10 markets are in California where employment and population growth is pushing vacancy rates lower in the state.

• Retail
  High income levels and strong job growth is pushing up demand for retail growth in the top market, Washington, D.C. Seven of the top 10 retail markets are in the Western U.S. where retail opportunities are being created by rapid increase in population.

• Industrial
  Five of the top 10 markets are near a major port facility, showing how important global trade is to the industrial real estate market. With a very low vacancy rate and a rare amount of land available for development, Los Angeles is the leader of the pack. Other cities in the top 10 include Houston, Dallas/Fort Worth, Seattle and Las Vegas.

Demographic trends are expected to increase the number of renters over the next 15 years in the apartment sector. Lower vacancy rates, rising land prices and rents, increasing construction costs and little new construction makes the office sector attractive. Retail's above-average returns could slow as the housing market cools and interest rates go. And industrial could be a good place to turn to. It has performed just as well as other sectors and is less risky.