Occupancy Rises, Rents Remain Stable

News of economic improvement across the nation continues to roll out.  Locally in San Angelo we have seen the same impact and continued increase in demand.  Unemployment remains low and it appears that we are having new businesses looking to relocate to the area.  The biggest push lately has been for yard space with warehouse/flex space.  Although the leads and calls have had a major increase in our office, the actual lease and move into the area is still a little slower than exected.  My assumption at this point would be for continued traffic leading towards a higher demand.  That being said, rents in our area have historically remained low, we did not see a dip in rates during the recent cruch but we have not seen much in the way of increased rents for many years.  The only major increase noted for this area has been in residential from apartments to rent houses to hotels, occupancy has also remained very high in these industries even with the increases. 

Below are some comments that should be relevant to our area as well as most other cities and states.  These comments were released in a recent article through CoStar in data search.

With Little New Supply Slated For Delivery, Landlords Should Slowly Gain Pricing Power If


Recovery Remains On Track

Although rising levels of office absorption and a falling U.S. vacancy rate signal a strengthening market,
the gains have yet to translate into meaningful rent increases for office landlords in most markets, CoStar
Group reported this week in the company's Second-Quarter 2012 Office Review & Outlook.
This week, CoStar analysts drilled deeper into the office market numbers in a report on the national office
market at midyear 2012 presented to CoStar clients. And while they see encouraging signs in the broader
CRE market, specifically in the office and industrial sectors, they cautioned that the recovery is likely to be
slow and dependent on the rate of job growth.
"Overall for the office market in terms of demand, it’s a pretty good story," said Hans Nordby, managing
director of Property and Portfolio Research (PPR), CoStar’s analytics and forecasting division. Nordby was
joined by Walter Page, PPR director of research; and Jay Spivey, CoStar senior director of research and
analytics.

Although office job growth slowed on a year-over-year basis to 1.9% from last quarter's 2.8%, it’s still
growing at a much stronger rate than the broader U.S. economy, which remains a nagging source of
concern to economists.

Office job growth is the life’s blood of real estate fundamentals. And those fundamentals are starting to
pick up momentum, with net absorption of U.S. office space more than doubling from 8 million square
feet in the first quarter to 18 million square feet in the second quarter of 2012. Despite the surge in
absorption "it's still not a screamer of a quarter" compared to the boom years of 2005 and 2006, Nordby
noted.

Net absorption over the last year has totaled about 63 million square feet, translating to a 0.9% rate of
growth in office demand, roughly half the rate of office job growth, Page noted. Houston, the nation’s top
energy market, led the nation in absorption growth at 3.1 million square feet of net absorption. The longsuffering

Atlanta market is starting to show significant demand growth.
At the other end of the spectrum, the pullback by pharmaceutical and insurance companies has resulted
in modest negative absorption in a handful of markets such as Northern New Jersey and St. Louis.
The office market is now reaping the benefits of job creation a year ago, especially in markets such as
San Francisco, New York, Minneapolis and Detroit. Other sectors such as financial services and
entertainment are starting to show job gains, nudging markets such as Orange County, CA into a stronger
recovery.

The vacancy rate fell slightly by 20 basis points to 12.6% in the second quarter from the previous
quarter, and is down 70 bps from a year ago. The slow rate of net absorption compared with the growth
in office jobs is due to the shadow space from the high levels of job losses during the past recession
without a corresponding loss of office demand. In short, tenants are burning off excess space that is left
over from the recession, before the need to lease additional space will be realized.

Copyright (c) 2012 CoStar Realty Information, Inc. All rights reserved.


Demand remains concentrated in top-tier 4- and 5-star buildings, achieving nearly double their fair share
of absorption of tenants take the opportunity to move up to higher-quality buildings, Page said. As the
recovery gains momentum and little new office supply on the horizon, absorption is spreading into lowergrade buildings, he said.

Gross leasing totaled roughly 95 million square feet per quarter between 2006 and 2009, a number that
has shot up to 125 million square feet on average during the last three years as tenants have sought to
upgrade their space, Spivey said. The 30% increase in leasing dovetails with a 10% decline in rents.
This year, deliveries of new office space as a percentage of inventory will total just 0.6%, far lower than
the 30-year average of just over 2%, Spivey said.

Don’t look for anything to change soon on the supply front. With no real uptick in construction starts, the
office market is still 3-4 years away from achieving significant new supply, with the scant level of new
construction tending to be highly preleased.

The higher absorption and lower vacancy has yet to translate into meaningful year-to-date gains in rents,
which are up only 0.7% from the same time last year, much of that driven by a 1.6% hike in Class A
rents. The prospect of future vacancy declines suggests that the scales are tipping toward positive office
rent growth, but growth has been underwhelming as of the end of the second quarter of 2012.
However, face rents move much more slowly than effective rents, as evidenced by landlords who are
starting to pull back from rent concession, tenant improvement allowances and other tenant perks in top
markets around the country, Nordby said.

While government spending driven markets such as Washington, D.C. posted the strongest rent increases
five years ago, technology and energy based markets such as San Jose and Houston are now leading the
charge.

Office investment sales are at roughly the same level as the first half of 2011, however, sales volume has
spilled beyond the top five U.S. markets into secondary markets with lower barriers to entry for new
supply.

Stronger Commercial Real Estate Outlooks

It appears that many of the recent conferences I have attended as well as many of the articles that are circulating point towards a more positive outlook than in recent months.  I have noticed a different attitude in today's market than we have seen in several years.  The article below by Mr. Ziegler is just one of several views or outlooks as to what the future may hold. 


Emerging Trends: CRE Profitability, Lending Look


Bright for Remainder of 2012

Commercial Property Executive

By Nicholas Ziegler, News Editor

The Urban Land Institute and PricewaterhouseCoopers L.L.P. have released the results of the annual Emerging Trends in Real Estate survey — and the

responses point to a stronger commercial real estate outlook for the remainder of 2012. The more than 195 participants “believe that profitability,

lending, and investor markets all show brighter signs” and that markets are looking up for CRE firms.

The survey, which has been issued for 33 years, is jointly produced by PwC and the ULI, and it includes survey responses from more than 950 leading

real estate experts, including investors, developers, property company representatives, lenders, brokers and consultants. For the mid-year survey, 195

participants who completed the original 2012 Emerging Trends survey were interviewed.

Most importantly, the survey showed a general trend toward optimism, even when compared with the year-end 2011 results. The number of

respondents rating profitability forecasts for 2012 as “excellent” rose by approximately 2 percent, and the number rating the category as “very good”

rose by the same amount. In fact, the only rating that fell was the “abysmal-fair” bucket, which dropped by approximately 10 percent.

According to the report, foreign investors and private equity will still lead the charge as active buyers of commercial real estate, but both values have

declined slightly. The biggest jump came from private local investors and public equity REITs. According to Real Capital Analytics through the first

quarter of this year, private-capital investors have completed the most deals, followed by public-equity companies.

The sources of debt capital values displayed some positive signs in the mid-year update. Insurance companies continue to be number one overall.

However, government-sponsored entities’ value increased over 11 percent from the original survey in November 2011. Other strong gains were found

in the CMBS market, commercial banks, and mezzanine lenders – all strong signs that the availability of debt is showing improvement. According to

Commercial Mortgage Alert, U.S. CMBS deals total $10.8 billion, up over 12 percent year-over-year. In addition, RCA states that there were increases in

lending as well in completed transactions.

Sentiment at ULI’s spring conference in Charlotte, N.C., in early May reflected the same results as the survey. During one of the sessions, Glenn

Grimaldi, executive vice president at HSBC, cited low interest rates as a major trend that is driving the real estate industry by allowing for low

acquisition cap rates. The low interest rates will also have implications on the amount of deleveraging as loans mature in the next few years, he said.

Grimaldi forecasted that banks may sell more loans at discount in the next years.