The Buzz

By Robert Bach, National Director of Market Analytics, Newmark Grubb Knight Frank

The disadvantage of a busy travel schedule is that it’s hard to get one’s regular work done. I say this as I gaze down from 30,000 feet at endless farm fields, which may or may not be in a speculative bubble. The advantage is that you learn some interesting things from talking with practitioners in the field – brokers, clients, researchers and consultants – who live in the trenches of their local markets. They see trends and anomalies in the market before they congeal into common wisdom. Here are some things I learned in the last two weeks:

• More than once I’ve heard the question: Is commercial real estate in a bubble? When interest rates rise, which is inevitable, will cap rates follow? This is the introspection of an industry trying to reconcile its recent good fortune on the capital markets side of the business with the sluggish recovery on the leasing side. The standard answer to this question is that the spread between the average cap rate across all property types and the 10-year Treasury yield is at an historic high, so there is some room for interest rates to rise before cap rates follow suit. A more nuanced answer is that deals requiring very low interest rates to pencil out may not fare so well when interest rates rise, but all-cash and low-leverage deals, the structure favored by institutional investors, should be OK, especially for core properties in primary, supply-constrained markets.
• Retail rents for the prime spaces across southern California have hit new peaks. This is a market where job growth has badly trailed U.S. averages.
• Institutional office landlords in Orange County, Calif. are including rent spikes in one or two outlying years of their pro formas. They expect office rents in this hard-hit market – formerly home to large subprime residential lenders and related tenants – to hit new peaks within two or three years.
• On the flip side, our research analyst for metro Washington, D.C. points out that, while rental rates have marched steadily higher in this hot market, rents adjusted for inflation (called “real” rents by economists) have stayed flat over a decade. Real rents in slower-growing markets have declined. Listen up tenants: Space is a bargain!
• Even so, tenants are taking less of it, reducing their space needs while keeping headcounts the same. This is one of the “big three” trends that is restraining the pace of recovery in the office market – along with sluggish job creation and the deep well of shadow space left over from the Great Recession that needs to be backfilled. Tenants are achieving their smaller footprints through shared office arrangements (hoteling) and creative office designs – open, collaborative spaces with fewer private offices.