Industry Outlook 2001 -- Services
If the past is any guide, the commercial and residential real estate industries should be taking a nosedive just about now. Developers typically overbuild toward the end of a growth cycle, setting themselves up for a price crash. Yet this time around, much of the industry is managing a soft landing on a relatively high plateau. Sure, growth in everything from downtown office space to suburban homes has slowed sharply from the double-digit growth rates of the past two years. But nowhere are there signs of collapse--not even in the handful of overbuilt markets, such as Atlanta and Dallas.
What gives? For one, financiers are still smarting from the last collapse in the early 1990s and have become more cautious in their lending. They're requiring that developers put up 35% of a project's equity and guarantee pre-leasing levels up to 60%. That has helped curb overbuilding. Also holding developers back are rising prices for material, land, and labor. And in the hottest markets--New York, San Francisco, Boston, Chicago, and Los Angeles--there's a shortage of space to build. To Janice Stanton, managing director of research at Cushman & Wakefield Inc., all this is good. "I see the frenzy coming out of the market--and it couldn't be coming at a better time."PUTTERING ALONG. Analysts aren't trying to argue that real estate has overcome its historical cyclicality. The point, they say, is that the cycles have become shorter and will spike less sharply up and down. "Unless the economy crashes, real estate should remain in relative balance," says Ray H. D'Ardenne, chief operating officer of Lend Lease Real Estate Investments Inc. What that means is that most industry segments, from office buildings to homes to hotels, will putter along at a 3% to 5% growth rate next year.
Make no mistake, however: There will be some pain. Housing starts, for example, are expected to fall to 1.43 million in 2001, down from 1.59 million in 2000. Sales of existing homes should also drop to 4.53 million, from 4.97 million. "This will be the single weakest year for single-family housing since the early 1990s," says Mark M. Zandi, chief economist at The Dismal Scientist, the economic research unit of Economy.com Inc. Still, 2001's figure could be a heck of a lot better than the one that triggered the 1991 recession, when housing starts plunged to 830,000.
Some markets will struggle more than others. In the Sun Belt, where zoning is lax and there's plenty of open land, housing and offices are overbuilt. "We have got a lot of inventory on the ground" in the Southeast, frets Terry Russell, president of Atlanta-based luxury residential builder John Wieland Homes & Neighborhoods.
Nationwide, the sectors that remain strong are downtown office rentals and construction, and luxury housing--especially in the top five markets of New York, San Francisco, Chicago, Boston, and Los Angeles. Businesses are set to absorb a total of 35 million square feet of new space annually, yet vacancy rates are at historic lows. In the office markets of New York and San Francisco, vacancy rates in the third quarter were at 3.2% and 2.3%, respectively--despite last year's dot-com implosion.
Luckily, the dot-coms represented a tiny part of the overall market--only 5% of all occupancy in New York, for example. Yet they did represent 20% to 60% of new business, depending on the market. "They were the cream in our coffee," says J. Thad Ellis, a managing director of CarrAmerica Realty Corp. (CRE) in Washington. In San Francisco, dot-coms will probably dump some 1.5 million square feet back on the market. But it's expected to be snapped up by other companies desperate for space. Indeed, nationwide rents are still expected to rise an average of 6% in 2001 in central business districts and 4% in suburban office markets, says Cushman & Wakefield's Stanton.
So, while business is slowing, real estate will remain surprisingly strong in 2001. It will continue to grow at a pace that will snuff out overbuilding in most markets and position the industry well for the next surge in development several years out.By Charles Haddad in AtlantaReturn to top