The Sad State Of Real Estate

These days, there’s a lot of uncertainty globally — and a little closer to home, in the cleaning world. The war in Iraq is winding down, but could aggression elsewhere follow? What will happen with severe acute respiratory syndrome, or Orange Alerts? And what about the economy? Thus far, we’ve avoided a “double-dip” recession, but a stagnant stock market and sagging employment don’t bode well for the immediate future.

New business prospects for many building service contractors seems also are riddled with question marks. Contractors may instinctively think of hunkering down, protecting their existing customer base and waiting until things pick up again before they entertain the idea of prospecting for new business (see related story, p. 29).

On the cleaning front, some stagnation can be attributed to a lackluster commercial real-estate market; high vacancy rates and a construction lull translate to fewer new buildings and fewer new cleaning contracts.



Empty offices

Office vacancies may seem unimportant to contractors — after all, even if a building is half-empty, there’s still at least some janitorial work to be done. But high vacancy rates mean there’s more office space available than the market demands, and that space will have to fill up before developers will be interested in constructing new buildings.

“When vacancies are high, new construction falls, and that’s exactly the trend we’re seeing now,” says Robert Bach, national director of market analysis for Grubb & Ellis, a commercial real-estate company based in Northbrook, Ill.

In the first quarter of 2003, there was 3.2 billion square feet of commercial office space in the United States, and 560 million of that, or 17.6 percent, was vacant, according to Grubb & Ellis statistics. A 10 percent vacancy level is considered “equilibrium,” the point at which supply roughly equals demand. Anything above that is considered a surplus; vacancy below 10 percent signals a tight real-estate market and the potential for new construction.

Suburban markets had larger vacancies than did central business districts (CBDs), with 19.3 percent and 14.6 percent, respectively. That’s because in many instances, suburban areas experienced a lot of new construction in recent years, and now have too much space.

In fact, for the greater part of the year, there has been negative absorption — that is, the net change in occupied space as fallen in each of the last nine months.

Vacancy rates in many key markets increased noticeably in 2002, according to “Global Market Rents,” a publication by CB Richard Ellis (CBRE), a Los Angeles-based commercial-real-estate firm. For example, in downtown Los Angeles, office vacancies reached 19.2 percent, due in part to accounting giant Arthur Andersen’s bankruptcy. The company closed approximately 138,000 square feet of office space.

San Francisco, still reeling from the decline of technology firms in the 1990s, has had negative absorption for the last 11 consecutive quarters. At the end of 2002, there were 16.5 million square feet of available office space, primarily attributable to new construction (much of which was begun before the recession) that remained unoccupied.

“Silicon Valley, Seattle — places that suffered with the downturn of the technology market also will take longer to recover,” says Jim Del Monte, assistant director of research for Cushman & Wakefield in New York. When thousands of “dot-com” companies went bust in the 1990s, they left empty office space, much of which has remained unfilled.

Still, some markets haven’t been hit as hard. For instance, the pharmaceutical industry is thriving with a sympathetic Republican administration and Congress and an aging population. So, New Jersey, home to many such firms, looks to pick up soon, according to the “Global Forecast” from Grubb & Ellis.

Also, vacancy rates are relatively low in Washington, D.C., with 5.6 percent of the CBD and 13.4 percent of the suburban office space vacant in the fourth quarter of 2002, according to CBRE’s publication, “Global Market Rents.”

Grubb & Ellis’ “Global Forecast” agrees:

“The District office market is anchored by the federal government and should get a long-term boost from defense spending,” says the report.

In addition, cities where the cost of living is low tend to be less impacted by technology-related and general economic downturns, says Darren Mewha, an analyst in LaSalle Investment Management’s Vancouver, British Columbia office. He expects those areas, such as Atlanta and Las Vegas, to recover soon.

LaSalle issues a quarterly “North American Regional Economic Growth Index” (NA-REGI), which analyzes 36 North American cities for employment, population, income, business costs and other trends in order to predict growth and potential investment opportunities. In addition to Atlanta and Las Vegas, three Canadian cities topped the NA-REGI — Toronto; Calgary, Alberta; and Vancouver.

The report cites a relatively strong Canadian economy for those cities’ inclusion, as well as a low cost of doing business and an influx of new residents for the growth potential in all five areas.



Breaking new ground?

With all of this excess capacity in existing buildings, the stimulus for new construction — and new BSC business — is non-existent. Jim de Lisle, Ph.D., director of the Runstad Real Estate Research Center at the University of Washington in Seattle, sums up the 2002 situation in his quarterly “Institutional Real Estate Update”:

“In this [economic] environment, opportunities for new development were tempered, with the exception of projects that were targeted for specific tenants and/or specialized niche opportunities for projects with significant pre-leasing,” he writes.

On the other hand, for most of 2002, developers were constructing very few new buildings unless they had specific tenants or buyers ready to sign. In mid-fall 2002, construction did improve, but only slightly. Further, many buildings that were completed in 2002 were planned a few years ago, when the market was stronger; as they were completed, new building starts did not replace them, so de Lisle warns investors to expect a construction lull during 2003.

“Given the current state of the economy and significant over-capacity in most property categories, the pace of starts is likely to remain tempered relative to that of the past several years,” he writes.

Grubb & Ellis statistics substantiate the downturn: 41 million square feet of office space was under construction during the first quarter of 2003, representing only 1.3 percent of the total office inventory. This is a significant drop from production in the mid-to-late 1990s, when as much as 124 million square feet were under construction at one time.

Moreover, new construction has been dropping steadily since mid-2000, both as a percentage of total office space and in terms of actual square footage.



No turnaround soon

This soft market may continue for awhile, as the economy sputters and corporate profits are low. When corporate profits are down, companies are reluctant to invest in new jobs, Bach explains. Without job growth, there’s no reason to expand into new space. Also, Americans in general are jittery about the war in Iraq and terrorism at home, and many corporate managers question their near-future need for new buildings.

“Companies are cautious,” Bach says. “Real estate is the last thing they’ll think of . They want to be sure of their own stability before they build new offices or sign a five-year lease.”

Experts agree that a recovery will take awhile, but their predictions vary as to when BSCs may start to see some new business opportunities. Overall, areas hit harder by the soft economy will obviously take longer to recover. Bruce Mosler, president of U.S. operations at Cushman & Wakefield, is optimistic.

“The right economic stimulus and continued success with the war in Iraq could accelerate stable markets into growth markets and softer markets into more stable ones,” says Mosler in a press release.

However, Bach advises BSCs it may take a lot longer, and they shouldn’t get too impatient with the economy’s lethargic pace.

“My advice is get over it, because it’ll be a slow recovery,” says Bach. “Leasing could pick up by the beginning of next year, but it could be awhile before vacancy rates fall enough to justify new construction. That could come as late as 2007.”