Economic Forecasts

Europe's Woes Hurt U.S. Commercial Real Estate

On the bright side, overbuilding is low and the the Russians have cash to spend.

Europe’s debt crisis will slow the recovery in commercial real estate in the U.S. Concerns over possible defaults on the other side of the Atlantic will mean chilly debt markets for a while longer, and less demand for exports threatens to sap the confidence of businesses. All that will keep job growth in the U.S. at modest levels, and, of course, less hiring means less demand for office space.

We estimate that the national office vacancy rate will fall from 18% at the end of the first quarter to near 20% by Jan. 1. Next year should bring a modest improvement, but only to the 18% vacancy rate of two months ago. And even that assumes steady job growth, looser reins on credit and renewed confidence among businesses and consumers.

A plus for the office market is the relative lack of overbuilding going into the recession. The pipeline of new office construction has been declining for seven straight quarters and stands at a 14-year low, according to Robert Bach, senior vice president with Grubb & Ellis. However, there’s a large amount of empty space that businesses are hanging on to that isn’t measured in the numbers. Bach says that such “shadow” space may be adding about four percentage points to the vacancy rate.

Another plus is an acceleration in investment by Russians looking for a safe haven. Until recently, the favored foreign destinations for Russians have been the high growth ex-Soviet satellites of eastern Europe or the slower but more stable economies of western Europe. Traditionally, only Russia’s superrich were willing to invest in U.S. real estate, and then largely in the form of second or third homes. But with the Greek debt crisis shaking the euro zone’s foundations and U.S. property markets near rock bottom, the U.S. is becoming an attractive investment for members of Russia’s new middle class. They’re looking not just at residential properties but at commercial real estate, too.

“The U.S. is very much a guarantee they are not going to lose their money,” says Edward A. Mermelstein, a real estate attorney and founder of Edward A. Mermelstein & Associates, which has offices in New York City and Moscow. “Many Russian investors … recognize that time is on their side. By purchasing at the lowest point, with the [U.S.] real estate market at its lowest point in some cases in 20 years, they get the benefit of stability, economic and political, compared to the rest of the world.”

Top destinations are likely to include New York and Florida, particularly Miami. In one prominent example, Mikhail Prokhorov, president of Onexim Group, a private investment fund, just bought the New Jersey Nets basketball team plus a 45% stake in the team’s future home, the Barclays Center in Brooklyn, N.Y.

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