Specifically, Grubb & Ellis expects property sectors to continue to move ahead in the following sequence, from best-performing to worst-performing: multi housing, hospitality, industrial, retail and office.
The report's analysis centers on two proprietary market indexes: a Momentum Index measuring near-term momentum for major property types heading into 2012 (U.S. baseline=100), and the Investment Opportunity Monitor, which identifies metropolitan markets with potential for investors over the next five years for specific property types based on a set of 16 to 20 variables. (Complete data follows release.)
Office Market Equilibrium Remains Elusive
In 2011, the office market recovery accelerated, but not to the speed of prior expansions in the sector. Regions scoring highest on the Momentum Index, which places them in the top quartile of markets analyzed, include Northern California/Pacific Northwest and Southern California, while Great Lakes/Ohio Valley and the Southeast were in the bottom quartile.
The "flight to quality" remains common in virtually every market across the U.S., and next year's continued recovery is highly dependent upon progress in resolving the financial turmoil in Europe. In the worst-case scenario, a reprise of the 2008 global financial crisis would impact New York's financial sector, while a deep recession in Europe and slower growth in emerging markets would hurt exporters ranging from manufacturers in the Midwest to technology companies in Silicon Valley. However, the more likely scenario is that Europe will avoid a catastrophe and the U.S. economy will muddle through one more year of subpar growth before a stronger recovery takes hold in 2013.
The outlook for the office market is stronger for 2012 with an expected national vacancy of 15.7 percent by year-end. Net absorption is projected to reach 52 million square feet and new deliveries will be minimal at 9 million square feet.
Rental rates are predicted to reach $31.38 per square foot for Class A space, up $0.24 from 2011, and $22.86 per square foot for Class B space, a $0.04 increase from 2011. Landlord-pleasing increases are unlikely to occur prior to 2013 or 2014, when the market reaches equilibrium. Class A properties will continue to outperform the general market, with only a small handful of markets tightening to the point where opportunities arise for owners of Class B properties to cut concessions, raise rental rates or upgrade their properties' status.
According to the Investment Opportunity Monitor, technology and/or biotech hubs offer the strongest long-term opportunities for office investors. The top six markets on the list – San Francisco, Seattle, Austin, Texas, and San Jose, San Diego and Orange County, Calif. – fit this profile as does No. 10 Boston. Also making the list were No. 7 Portland, Ore., and No. 8 Los Angeles. New York, last year's top-rated market, moved to the ninth slot as the eurozone crisis threatens the city's financial sector. Washington, D.C., last year's runner-up, didn't make the list this year, penalized by its strong construction pipeline and the uncertain outlook for federal spending.
Industrial Sector Stable Thanks to Limited New Supply
Demand for industrial real estate accelerated significantly in 2011, with total net absorption of 110 million square feet, up from only 34 million square feet absorbed in 2010. This trend is expected to continue in 2012, but due to the uncertainty overseas and the sluggish domestic economy, Grubb & Ellis researchers expect an increase in total net absorption of only 15 percent to 130 million square feet. Regions scoring above the U.S. baseline of 100 on the Momentum Index include Southern California, Texas/Great Plains and Northern California/Pacific Northwest. Regions with the lowest Momentum Index scores are Mountain/Southwest and Great Lakes/Ohio Valley.
Industrial vacancy, which fell 90 basis points in 2011 to 9.5 percent, is projected to continue to decrease and hit 8.7 percent by year-end 2012. New supply is expected to double to 40 million square feet in 2012 after remaining constrained throughout 2011.
"The greatest milestone of 2011 was the lease-up of all the space vacated during the recession," said Bach. "The lack of new deliveries funneled demand to existing properties, giving the market time to heal."
Large blocks of warehouse/distribution space should continue to outperform, while general industrial and R&D/flex segments need another year to recover before landlords begin raising rental rates.
The price for warehouse/distribution space is expected to increase to $4.44 per square foot in 2012 from $4.23 per square foot in 2011, while asking rental rates for R&D/flex space are predicted to increase $0.02 to $9.25 per square foot during the same timeframe. Rates for general industrial space are expected to remain flat at $4.94 per square foot. As in the office sector, smaller, second-generation warehouse spaces likely will continue to struggle despite aggressive concession packages and depressed rent levels.
Although industrial investment opportunities do exist in local and regional markets, according to the Investment Opportunity Monitor, the top 10 prospects are those markets serving seaports or inland ports that benefit from growing international trade. Los Angeles, with the largest port complex in the nation, took the top spot. The next eight markets fit the port profile – Houston (No. 2), Inland Empire, Calif. (No 3), Dallas-Fort Worth (No. 4), Chicago (No. 5), Miami (No. 6), Oakland-East Bay, Calif. (No. 7), Atlanta (No. 8) and Philadelphia/Central Penn. (No. 9). Phoenix made the list at No. 10 due to its success in attracting large tenants that historically would have ended up in California.
Retail Will Lag until Consumer Confidence Returns
The struggling housing market, weak job growth and ongoing consumer deleveraging caused the retail market to lag other property sectors in 2011. Demand from mid-size tenants was limited and the majority of transactions were smaller deals. Neighborhood and community center vacancy rates were stable but not falling, while vacancies in regional malls inched up slightly. Regions scoring highest on the Momentum Index, which places them in the top quartile of markets analyzed, include Southern California and Northern California/Pacific Northwest. The bottom quartile included the Mountain/Southwest region, where the housing bust was particularly severe, and the Great Lakes/Ohio Valley.
Very little retail construction is occurring nationally. This combined with moderate job growth and rising retail sales should help sustain a recovery in 2012, although velocity will not be strong enough to push lease rates higher. Struggling landlords will continue to look for non-traditional retailers such as trampoline facilities, nail salons and cooking schools to fill space.
The majority of investment activity has been in larger, primary markets, while tertiary markets have seen little capital for deals. The results of the Investment Opportunity Monitor indicate that this trend will continue. Los Angeles topped the list, followed by Washington D.C. (No. 2), Boston (No. 3), San Diego (No. 4), Seattle (No. 5), Portland, Ore. (No. 6), San Francisco (No. 7), Houston (No. 8), San Jose-Silicon Valley, Calif. (No. 9), and Austin, Texas (No. 10).
Multi Housing Sector Poised for Repeat Strong Performance
The multi housing sector was among the strongest performers in 2011. During the year, effective rental rates and occupancy rates increased, with only 38,000 units added to the market. Tough qualifying standards for prospective home buyers and the growth of the 18- to 34-year-old age group ensure that this sector will continue to be one of the most popular and sought-after commercial real estate investments in 2012.
A close look at the Investment Opportunity Monitor reveals that top markets in the multi housing sector have higher home prices due to their coastal locations and other barriers to entry coupled with stronger prospects for job and population growth. The San Jose-Silicon Valley, Calif., region ranked No. 1 on this list, followed by New York City (No. 2), Boston (No. 3), San Francisco (No. 4), Orange County, Calif. (No. 5), Los Angeles (No. 6), San Diego (No. 7), Oakland-East Bay, Calif. (No. 8), Portland, Ore. (No. 9), and Washington D.C. (No. 10).
Across all property types, distress is expected to remain high but the composition will shift with fewer such properties on offer by banks and more from CMBS servicers.
"The wild card this year is the unresolved European debt crisis, which has the potential to send lenders and investors to the sidelines," Bach said. "If they stay in the game, expect overall commercial real estate sales to rise 25 percent in 2012, generating marginally lower cap rates for non-distressed assets."