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Thursday, May 31, 2007

Commercial Real Estate Update

by Calculated Risk on 5/31/2007 06:57:00 PM

There is no question that investment in non-residential structures is still strong. As an example, from the Orange County Register: Commercial real estate still roars

"Orange County is one of the high spots for commercial real estate," said Scott MacIntosh, a senior economist with the National Association of Realtors. "There's low vacancies and high investor interest."
"Commercial drivers are stronger than ever, and I have never seen so much money pouring into Orange County,"[ CB Richard Ellis' Barry Katz] said. "There's still billions of dollars chasing Orange County property."
The construction spending report today showed that private non-residential construction investment was still very strong in April. And investment in non-residential structures for Q1 was revised upwards in the GDP release today. Both reports confirmed what we already knew - CRE is booming.

However, the above article goes on to note that the Orange County office market is "facing [a] glut" later this year. That is also true nationwide, in fact vacancy rates have already started to rise, and there is significant more supply scheduled to be delivered later this year. From a personal perspective, when I drive around Orange County (where I live), I see commercial construction projects everywhere, and I also see more and more "For Lease" signs on existing buildings. An interesting combination: more supply coming while vacancies appear to be increasing.

It was just two weeks ago that I asked: Commercial Real Estate: Slump Ahead? I tried to connect the dots: rising vacancies, significant supply coming on line later this year, lower demand reported for CRE loans, many banks over exposed to CRE lending, etc.

Commercial Real Estate InvestmentClick on graph for larger image.

Here is an update to the second chart in the previous post, including the revision to the GDP report today. This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In the typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for four straight quarters (following two minor declines). So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

I believe that continued strong non-residential investment (both structures and equipment and software) is one of the keys to avoiding a recession this year.