Sunday, March 11, 2007

Commercial Real Estate Bust?

by Bill McBride on 3/11/2007 03:46:00 AM

First, here are two very different stories ...

From the LA Times: Businesses pinched as commercial rents soar in Southland

Sizzling demand for offices, warehouses and retail space is hitting Southern California and other major urban centers. ...Office rents have climbed more than 25% on average in the last three years in much of Los Angeles County.
Vacancies have plunged to well below 10% in many areas, making it harder for businesses to find space. Only 3% of the region's industrial space — used for warehouses and factories — is available, a level that is considered drastically low.
And from the Press-Enterprise: Office-space surplus plagues Coachella Valley
The Coachella Valley has too many offices for too few employers willing to rent them, but that hasn't stopped developers from planning projects with more than 1 million square feet of office space ...

Brokers said up to 23 percent of the offices in the Coachella Valley are seeking renters or buyers. A healthy office-building market occurs when vacancies are less than 10 percent.
In some areas, commercial space is clearly limited. But in most of Southern California, and in many parts of the U.S., there is a commercial building boom occuring right now.

This should be expected. Historically non-residential construction follows residential construction. In an earlier post, I graphed the investment lags for non-residential investment compared with residential investment. Here is the graph:

Click on graph for larger image.

The highest correlation for non-residential structures is a lag of 4 to 5 quarters. There is a positive correlation for other periods also. For non-residential structures, a lag of 5 quarters would suggest the YoY change would turn negative in Q3 2007. Update: The seasonally adjusted annualized change in structure investment was a negative -0.8 in Q4 2006.

This second graph shows the CRE delinquency rate vs. private non-residential construction spending. In the previous commercial real estate (CRE) slowdown, the delinquency rate started rising a couple of quarters before construction spending slowed.

The delinquency rate is rising again, although this time from a much lower level. This could be an indication that non-residential construction spending is about to peak.

And the third graph shows non-residential construction employment. Note: graph starts at 3 million to better show the change.

Non-residential construction employment has been flat for about four months, after a significant increase in employment in 2006. This might be another indicator that CRE investment is peaking.

This might be a story later this year: the start of a commercial real estate bust.