Office, Other Commercial Property Rents to Rise in 2013

Like the economy as a whole, the commercial real estate market will strengthen over the coming year.

You’re going to need some faith this winter. Odds are the economy will be pretty grim in early 2013, though it will pick up substantially later in the year. With job growth only mediocre and incomes lagging, consumer spending won’t grow fast, and it will take some time for business spending to gear up, once worries about the fiscal cliff dissipate.

We expect Congress and the White House to reach agreement during Congress’ lame-duck session on at least a framework for tax hikes and spending cuts. That would pave the way for a short-term extension of current tax rates and the deferral of pending federal spending cuts, while assuring investors and businesses that a comprehensive deal will be concluded in 2013. Regardless of the outcome of negotiations on avoiding the cliff, cuts in government spending are sure to sap some strength from growth.

Still, by year-end, GDP should be gaining at an annualized pace of about 3%, and for 2013 as a whole, a gain of a bit more than 2% is a fair bet. Jon Southard, managing director for CBRE Econometric Advisers, says, "Commercial real estate next year? Grinding higher, marginal improvement rather than wholesale gains."

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One sector where the slow upward grind will be apparent: commercial property. Robert Bach, national director of market analytics for Newmark Grubb Knight Frank, says, "If we avoid the fiscal cliff, 2013 for offices will look a lot like 2012. That's not all bad. There will be steady gains in leasing and fairly strong investor demand."

Office rents will inch higher across much of the country as gradually rising demand soaks up surplus space and new office construction remains very low. One potentially big exception is the Washington, D.C., metro area, where the threat of deep cuts in federal spending casts a long shadow.

Bargains on office space will be harder to come by. Concessions that landlords made a year ago have already vanished, and rents are headed up an additional 3% in 2013. With the pace of hikes likely to accelerate in 2014, consider acting sooner in the year rather than later to ink long-term leases on space that you will need. The strongest markets: cities with big footprints in energy or technology -- Boston; Minneapolis; Dallas; Oklahoma City; Denver; San Francisco and San Jose, Calif.; Portland, Ore.; and Seattle, among them. Nationwide, vacancy rates will slide from 15.5% now to about 14.5% in 2013 -- still well over the prerecession rate of 12.6%.

Available warehouse space is also being whittled, though more slowly. Figure on a national vacancy rate near 12% by year-end 2013, down from 13% now, with rents rising a bit over 2% next year after climbing a tad less than 2% in 2012. Among the warmer markets: Seattle, Denver and San Diego. Port cities, too, including L.A., Houston and Philadelphia. But for most metro areas, including Dallas, Chicago and Atlanta, newer buildings will simply cannibalize demand for older space.

Even the much-battered market for retail space is brightening, with rents headed a whisker higher on average in 2013 after finally bottoming out this year.

From an investor perspective, apartment buildings retain the most appeal., Vacancy rates continue to slide, and rents…up 4% this year…will climb 4.5% in 2013 as the economy adds 2 million net new jobs, spawning more household formation. Some standouts: Orlando, Fla.; Houston; Phoenix; Denver; Salt Lake City; and the San Francisco Bay area. Neighborhoods near commuter rail lines are hot.

There is some concern about too many units under construction, but In most areas, excess capacity is still another year or two away. Mark Vitner, senior economist at Wells Fargo Securities, says, "There's some concern about a concentration of apartment construction, but I don't have a sense of dread about the sector. That said, rents won’t continue strong for much longer, and risks are rising. By 2014, look for young folks who have steered clear of home buying in recent years to enter that market, sapping demand for apartments and moderating rents.

Jerome Idaszak
Contributing Editor, The Kiplinger Letter
Idaszak, now retired, worked on The Kiplinger Letter as its economics writer for 21 years. Before joining Kiplinger in 1992, he worked for 15 years with the Chicago Sun-Times, including five years as a columnist and economic correspondent in the Washington, D.C., bureau, covering five international economic summit meetings. He holds bachelor's and master's degrees in journalism from Northwestern University.