October 2007 Quarterly Forecast
> Commercial Real Estate
COMMERCIAL REAL ESTATE
By Ryan Ratcliff
For California as a whole, most of what we need to know about real estate’s role in economy over the past five years comes from the residential side. However, the severity of the tech bust and the relatively small role that new building has played in the Bay Area together mean that we’re missing a significant portion of the story if we don’t take a look at non-residential construction. Of course, the relative importance of residential construction versus non-residential construction varies across the region. Figures 9 and 10 suggest that we can divide the six Bay Area counties into three groups.
The first group is Alameda and Santa Clara Counties, where commercial construction has been the primary story. Both counties have seen the five-year average value of non-residential building permits falling steadily since the heyday of the late 1990s. At the same time, the residential building boom has been mostly a non-event in this group. The five-year annual average value of residential building permits in Santa Clara County has stayed roughly constant since the late ‘90s average, while Alameda County’s residential construction has shown a small but significant boom. Thus, construction activity of all sorts has been adding steadily less to the economies in this group.
Figure 9: Average Annual Valuation of Residential Building Permits ($1000s)
Source: CIRB, UCLA Anderson Forecast
Figure 10: Average Annual Valuation of Non-Residential Building Permits ($1000s)
Source:
CIRB, UCLA Anderson Forecast
The second group of Contra Costa and Marin Counties is pretty much the opposite of the first group: here, the residential building boom is the primary story. As we have noted before, Contra Costa’s residential building boom was far and away the biggest in the Bay Area. Unfortunately, the drop in annual average value of residential construction in 2006-7 compared to the previous five years is also unparalleled in the Bay Area, and in fact rivals the commercial real estate bust in Santa Clara County in the wake of tech boom. At the same time, Contra Costa County is the only county in the Bay Area where the average value of non-residential construction was higher from 2001-5 compared to the late ‘90s. Marin County shares several of these features: after a small residential building boom in 2001-5, the average annual value of residential permits issued in 2006-7 is back down the levels seen in the late ‘90s. Also, the value of Marin County’s non-residential permits has been consistently dwarfed by residential construction, and has not seen much fluctuation over the period. The importance of residential construction and its recent swings means construction has made a big but volatile contribution to these economies – as it has to California as a whole. However, lumping Marin County’s small fluctuations in with Contra Costa’s building bust may be a bit unfair…
The last group (San Francisco and San Mateo Counties) represent the middle ground between the first two. Non-residential permit values represent the majority of construction activity over this 17 year period in both counties. They both experienced a small falloff in commercial construction in the wake of the tech boom, but average non-residential permit issuance over the last two years has exceeded the level of the late 1990s. Lastly, while both of these markets have seen consistent increases in the value of residential permits, San Francisco has actually seen a higher average annual value of residential permits in 2006-7 than in any previous period, while San Mateo shows a slight decrease in the same period. Throughout the Peninsula, both residential and commercial markets are doing well, even as real estate in the rest of California sags.
The office market is a logical place to start looking more closely at non-residential real estate: it was the main beneficiary of the tech boom, and one of the main casualties of the tech bust. All three major metro areas saw a substantial spike in office vacancies in 2001, though the East Bay’s spike was not nearly as severe as the San Francisco or San Jose metro areas. But in the years following the tech bust, we’ve seen some paradoxical behavior in office markets. Office-using employment in the East Bay has recovered to within 1% of its pre-recession levels, while San Jose and San Francisco are still 11% and 36% off their peak levels of office-using employment, respectively. Yet vacancy rates in the East Bay have yet to come down from their recession highs, while office markets in the other metros have seen significant drops in their vacancy rates. Why have vacancy rates remained higher in the East Bay? While its dangerous to make any statements that lump the office markets of downtown Oakland and Brentwood into the same category, we can still gain some insight from comparing the difference between net absorption (new demand for office space) and net completions (net additions to the supply of office space) across the metro areas.
Figure 11: Bay Area Office Vacancy Rates
Source: PPR, UCLA Anderson Forecast
Office markets are highly inertial. When demand for office space throughout the Bay Area exploded in the late 1990s, even the frantic pace of building was not able to wholly satisfy this new demand, leading to historically low vacancy rates by 2000. Unfortunately, when demand for office space plummeted in 2001-2, the boom in office construction continued for another year and a half – most of these projects were already past the point of no return when demand fell. In this environment of negative net absorption and peaking completions, vacancy rates skyrocketed and office rents plummeted.
Figure 12: Net Office Absorption (1000s sq. ft.) – Net Office Completions (1000s sq. ft.)
Source: PPR, UCLA Anderson Forecast
With this glut of office space, it’s hardly surprising that new additions to the stock of office space slowed to a trickle. However, as we’ve seen in the recent employment numbers, PBS employment has come back strong in the past two years in the Bay Area. The combination of faster growth in demand for office space and slower completions of new office space have brought vacancy rates down in the San Francisco and San Jose metros, and have spurred a recovery in rent growth. In the East Bay, demand has grown slower, allowing most new demand for office space to be satisfied out of net completions, rather than dipping into the existing inventory of vacant space. Thus, East Bay vacancy rates remain high even though office-using employment has mostly recovered from the 2001 recession. 2007Q2 shows a substantial increase in the difference between net absorption and net completions, but it is unlikely that represents a change from the existing trend: close to 700,000 square feet of office space are due to complete in the next 12 months.
|
