UCLA real estate experts recently published an analysis of the commercial real estate industry as part of the monthly UCLA Economic Letter, in which senior economist David Shulman dishes out “the good, the bad, and the ugly.”

While the commercial sector sees ups and downs just like the residential sector, commercial construction spending has grown steadily–and substantially–since 2010. However, spending has recently plateaued around $140 billion annually, as shown by the chart below.

Apartments & Industrial

Shulman points out the positive trends in two of the four largest commercial categories: apartments and industrial. A decline in homeownership from 64.8% to 64.2% means more people are renting (possibly due to delayed marriage and child-bearing among Millennials). This is why rental rates continue to rise by 3-4% per year and developers are building more apartments now than ever: 380,000 units annually over the last four years compared with 114,000 in 2010.

Median rent in Contra Costa County is well ahead of the rest of California, at nearly $1,766/mo across all housing types as of 2017 Q4. Respective state median rent is at $1,447 (Source: Department of Numbers).

Industrial rents rose at nearly double the rate according to the UCLA Economic Letter, between 6-8% annually. This is due in part to the rise in eCommerce business and the corresponding need for warehouse and distribution centers.

Office

Shulman identifies the threat that the coworking effect has on the office sector: declining square-footage per employee. The average employee has only 150 square feet of office space, down from the previous average of over 200 square feet. Office users’ decreasing space per employee results in higher office vacancy: now up to 16.6%.

Retail

The retail sector is what Shulman calls “the ugly” of the current commercial climate. The eCommerce boom has led nearly 6,000 retail locations to announce they’re closing in 2019. And although many online retailers are now opening physical locations, they maintain a fraction of the square footage of the retailers they are replacing. Shopping centers and malls are experiencing vacancy rates of 9-10%, comparable to recession-level rates.

As we can see, the commercial sector does not always ebb and flow as one, but each category is affected differently by shifts in the economy at large. As an investor, broker, or developer, it is important to keep a finger on the pulse of the market in order to make the best decisions for long-term success.

Effect on Commercial Real Estate Values

Trends in rental demand and usage will likely affect the value investors apply to individual real estate sectors. Those sectors with increasing vacancy will see declining values as investors weigh the greater risk and demand less of it for their portfolios or a greater return to offset the greater risk.

Those sectors with strong rent growth and lower vacancy (currently industrial and multi-family), will likely see strong demand from investors as the vacancy risk is lower and investors foresee rent growth. How soon investors start to make these adjustments is yet to be seen.

If you want to know how changes in the commercial market may affect the value of your commercial real estate, reach out to Maclennan Investment Group by email: peter@maclennaninvestments.com or phone: (925) 385-8798 and see how we can assist you.