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The economy – not to mention the commercial real estate sector – is looking for some sparkle this holiday season. While the third quarter brought some positive news to commercial real estate, economic concerns continue to hold back a robust commercial real estate recovery. Still, while commercial real estate markets have been relatively flat this year, improving fundamentals mean a more positive trend is expected in 2012.

Let’s look at the overall economy first. Based on the Bureau of Economic Analysis’s second estimate, gross domestic product (GDP) rose 2.0 percent in the third quarter. Mirroring the second quarter’s patterns, all major components advanced, except government spending. The major driver of economic growth – consumer spending – remained steady growing 2.3 percent during the third quarter. Business investments provided a double-digit boost behind the economic advance. Business spending rose 14.8 percent during the quarter. Businesses have accelerated spending with each successive quarter during 2011. Businesses upped their spending on equipment— transportation was up 31.7 percent while spending on industrial equipment rose 31.6 percent. Notably, spending on commercial real estate gained for the second consecutive quarter, advancing 12.6 percent.

International trade, which has proven resilient this year, continued to expand during the third quarter. With exports rising by 4.3 percent and imports growing by 0.5 percent, the balance of trade was positive. However, along with growth in trade, prices of exchanged goods also increased. Import prices, in particular, have been growing at double-digit rates for the better part of 2011, with September’s prices 13.4 percent higher year-over-year. Export prices rose at a much slower pace, with September 2011 figures up 9.5 percent from the prior year.

On the employment front, there’s still a lot of room for improvement. The number of payroll jobs rose by 368,000 during the quarter. Businesses cite general uncertainty, lack of demand and regulatory concerns as the main reason for modest hiring. Still, manufacturing, construction and mining maintained a steady pace of growth. Another positive sign: professional and business services posted a net 100,000 new jobs during the quarter. The other contributors to employment growth were the education and health sectors.

Commercial Markets

According to NAR’s latest Commercial Real Estate Outlook, there was little change in most of the commercial market sectors in the third quarter of this year. Vacancy rates continue flat, leasing soft and concessions continue to make it a tenant’s market. But the commercial real estate market is expected to follow the general economy, and NAR foresees continuing, albeit modest, improvement. Vacancy rates are expected to trend lower and rents should rise modestly next year. In the multifamily market, which already has the tightest vacancy rates of any commercial sector, apartment rents will be rising at faster rates in most of the country next year. If new multifamily construction doesn’t ramp up, rent growth could potentially approach 7 percent over the next two years.

Office Markets: Vacancy rates in the office sector are expected to fall from 16.7 percent in the current quarter to 16.1 percent in the fourth quarter of 2012. Currently, markets with the lowest office vacancy rates are Washington, D.C. (9.3 percent), New York City (10.3 percent) and New Orleans (12.8 percent). Office rents rose 1.4 percent in 2011, and are expected to increase another 1.7 percent in 2012. Net absorption of office space in the U.S., which includes the leasing of new space coming on the market as well as space in existing properties, is projected to be 20.2 million square feet this year and 31.7 million in 2012.

Industrial Markets: Industrial vacancy rates are projected to decline from 12.3 percent in the fourth quarter of this year to 11.7 percent in the fourth quarter of 2012. The areas with the lowest industrial vacancy rates currently are Los Angeles, CA with a vacancy rate of 5.2 percent; Orange County, CA at 5.7 percent, and Miami at 8.4 percent. Annual industrial rent is forecast to rise 1.8 percent in 2012. Net absorption of industrial space nationally should be 62.0 million square feet this year and 41.2 million in 2012.

Retail Markets: Retail vacancy rates are likely to decline from 12.6 percent in the current quarter to 11.8 percent in the fourth quarter of 2012. Markets with the lowest retail vacancy rates include San Francisco, CA (3.7 percent), Long Island, NY and Northern New Jersey, each at 5.7 percent, and San Jose, CA at 6.0 percent. Look for average retail rent to decline 0.2 percent through the end of this year, and then rise 0.7 percent in 2012. Net absorption of retail space is expected to register 1.2 million square feet this year and 13.5 million in 2012.

Multifamily Markets: This sector has been the performer over the past year, and will continue to perform well in 2012. The apartment rental market – multifamily housing – is expected to see vacancy rates drop from 5.0 percent in the fourth quarter to 4.3 percent in the fourth quarter of 2012; multifamily vacancy rates below 5 percent generally are considered a landlord’s market with demand justifying higher rents. Areas with the lowest multifamily vacancy rates currently are Minneapolis at 2.4 percent, New York City, 2.7 percent, and Portland, OR at 2.8 percent. Average apartment rent is projected to rise 2.5 percent this year and another 3.5 percent in 2012. Multifamily net absorption is likely to be 238,400 units this year and 126,600 in 2012.

By George Ratiu, Manager, Quantitative & Commercial Research