Commercial real estate, or CRE, is one of the more straightforward and relevant indicators of the overall health of the U.S. economy. Others, such as the stock market, tend to be heavily biased toward economic activity abroad. GDP is the most comprehensive measure of the economy, but it takes time to get through the full report and it includes a lot of data not relevant to most people. CRE tells a relevant story easily understood by the average person.
Three important performance metrics are associated with CRE: vacancy rates, rent, and delinquencies. If vacancy rates fall, rents rise and/or delinquencies decline, landlords can more easily repay their debts. This would mean commercial mortgage-backed securities (CMBS) are less likely to default, and ultimately CMBS investors will see the value of their investments rise. These investors include pension funds, insurance companies, and banks.
CRE also reveals much about our jobs and the health of the businesses we work for. If delinquencies decline, for example, we can surmise that higher sales are enabling more business tenants to be current on their lease payments.
Falling vacancy rates can indicate several positive phenomena. A business may be expanding its space to store more inventory in response to higher sales levels. This is necessary to stabilize inventory turnover rates and prevent shortages.
Businesses may also need the extra space for capital equipment. For example, a carpenter may need more space for an extra table saw to fulfill an increasing backlog of orders. These capital expenditures indicate that the buyer is growing, but it also is positive for the business selling that equipment.
Perhaps the most encouraging implication of falling vacancy rates is increased hiring activity. If a business is taking on more employees, it will need space for additional desks, more lockers, or a larger break room. Hiring also means more paychecks for consumers who in turn can spend that money and fuel self-sustaining economic growth.
While it continues to be weak, the domestic CRE market has been showing signs of stabilization and perhaps improvement. According to CRE research firm Reis Inc., the national office space vacancy rate was flat in last year’s fourth quarter. However, this is a notable improvement after more than three years of quarter-over-quarter increases. Reis also noted that the average asking rent climbed 0.2 percent from the previous quarter to $27.53 per square foot, the first increase since the second quarter of 2008.
According to Moody’s, delinquencies in loans securitized in CMBS climbed more than a tenth of a percentage point month-over-month to 8.79 percent in December. While rising delinquencies may not seem like good news, this rate has been decelerating. And delinquency rates must decelerate before they can start falling.
Recent reports point to increasing strength in the CMBS market. Improved liquidity in the CMBS market puts capital back to the original commercial mortgage lenders, which ultimately makes it easier for the small business own to lease new space.
All these are encouraging signs for the U.S. economy.
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