What Immediate Forecasts Mean for Office Building Owners and Investors

By Hana R. Hong, Manatt, Phelps & Phillips LLP

During the first quarter of 2016, several outlets including Morgan Stanley and Forbes.com expressed concern about the commercial real estate industry’s new-year optimism. Although such opinions appeared to be contrary to those of many U.S. real estate experts, in hindsight they have turned out to be well founded.

Given the slowing numbers in CRE market performance over the past several months, prudent CRE owners and investors in office and mixed-use properties may want to consider the following when assessing the second half of 2016:

• The last quarterly issue of the National Association of Realtors’ Commercial Real Estate Outlook stated that U.S. businesses in the first quarter generally “cut back investments in … commercial real estate.”
• Such caution appears consistent with the overall upward trend in CRE valuations—currently higher than pre-2008 levels, according to the May 5, 2016, Green Street U.S. Commercial Property Price Index.
• An Urban Land Institute leader and director of North American strategy at LaSalle Investment Management, William Maher, recently said: “(C)ompared to six months ago, real estate researchers are predicting slower economic growth, slipping real estate fundamentals and lower returns. … (There’s) no imminent downturn on the horizon, although global economies … remain fragile and volatile.”
• According to the April 2016 ULI Real Estate Consensus Forecast (ULI Report), commercial price appreciation through 2018 is among the top 10 CRE indicators “forecasted to be worse than their 20-year averages,” and the projected decline in commercial property price growth is expected to slow down CRE activity nationwide over the same time period.
• However, per the ULI Report, U.S. employment rates are increasing, translating into a projected demand for office space and an overall modest decline in 2016’s national office vacancy rates to 12.6 percent.

In light of the above, office building owners looking to bolster occupancy rates until commercial prices rise again may consider at least two strategies:

• Think of different ways to use existing office spaces to increase the economic return on the same amount of square footage.

According to Walter Page, Director of Research – Office for CoStar Portfolio Strategy, in the April 21, 2016, installment of The Commercial Real Estate Show, a nationally syndicated podcast, “Try(ing) to anticipate the needs of the future … (is) the key to the whole thing.”  Among other strategies, landlords can think of how to attract and retain commercial tenants with given space, such as updating amenities; increase flexibility in both leasing and space design more appealing to today’s design- and brand-oriented enterprises; and identify shared spaces that could increase operational efficiencies and cross-business opportunities within commercial properties.

• Look to secondary markets and investment properties to secure future opportunities.

Citing dipping demand in traditional technology and urban markets, Page encourages investors to consider the opportunities in occupancy-challenged buildings—those less than 85 percent occupied—in certain neighborhoods of markets like Los Angeles; Washington, D.C.; and Boston. Page suggests tenants and investors alike find these secondary markets attractive for maintaining good demand and they are also not “priced as richly as the (central business districts in the same markets).”

Regardless of whether the CRE market goes up or down, there will always be opportunities for those market participants willing to take calculated risks, which means that now is the time for commercial owners and investors to work with their attorneys to evaluate and implement creative strategies.

Hana R. Hong is an associate in the Real Estate & Land Use Practice Group at Manatt, Phelps & Phillips LLP, located in the Los Angeles office.