The commercial real estate market is in great shape. No, wait. Commercial real estate is headed downhill. Oh, excuse me. I meant to say that real estate is the only decent investment out there.

The previous schizophrenic paragraph is brought to you by the Association of the Creation of Statistics to Confuse and Annoy.

Don't misunderstand -- statistics can be an excellent guide to the world around us. They reveal trends, point to likely future events and help delineate fact from fiction.

But over the last couple of weeks, the statistical and trend information released regarding real estate has served to further confuse, rather than clarify, the direction that the market is heading.

For starters, take a look at the National Real Estate Index, which demonstrates that during the second quarter, office rents saw their largest decline since the early 1990s.

Average rents dropped in all six property sectors, with central business district office space experiencing a decline of 3.2 percent. Suburban offices averaged a 2.2 percent drop.

The most dramatic decreased occurred in California, where high-tech hubs and major urban centers suffered. California faced the biggest quarterly fall in rents in five of the six major property sectors.

Between the first and second quarters 2001, CBD office rents in San Francisco and San Jose fell by 14 percent and 8 percent, respectively. Their suburban office rents dropped by 12.5 percent and 19 percent. CBD office rents also fell in Chicago, Philadelphia, Nashville, Atlanta and Austin. Other markets reporting declines in suburban office rents included Jacksonville, Columbus, Boston and Denver.

This broad slowdown, however, may be only a blip on the real estate screen. Many of the industry's major players believe that real estate is well-positioned to weather a slowing economy and will establish a pattern of steady investor returns in an otherwise choppy market.

"The errors that paved the way for the last downturn in commercial real estate in the late 1980s -- too much capital, overbuilding and overvaluation -- are nowhere in evidence now," said John Petrovski, group president of Heller Financial's real estate business unit. "Real estate has successfully policed itself against overzealous lending and excessive inventory, making it a 'poster child' for good industry behavior in today's economy.

"By putting the hard-won lessons from its past to good use, real estate has been able to provide a stable investment alternative to the rocky reception many investors are encountering in the equities markets," he added.

Heller is banking on consolidation of real estate investment trusts (REITs) leading to market efficiencies, such as a lower cost of capital, which both creates operating efficiencies and ensures its competitive advantage as an investment.

"Because it qualifies as a 'hard' asset, real estate offers a real measure of security at a time when other investment categories are likely to vacillate," said Petrovski. "Real estate might not have the short-term upside potential of a hot equity stock, but it doesn't present the downside risk either. What it lacks in volatility it makes up for in long-term viability."

But then we turn back to those darned statistics. CB Richard Ellis points out that the pace of rental growth in Class A office space has slowed dramatically around the world in the last six months, due largely to corporate reaction to the slowdown in the U.S. and Japanese economies and the meltdown in the worldwide technology sector.

California's Silicon Valley, which in January 2001 became the sixth-most expensive office market in the world with a total average occupancy cost of almost $90 per square foot, was the hardest hit market in North America in the last six months with total occupancy costs slipping to $68.90 per square foot per annum.

"The depth of the economic slowdown in the U.S. and the speed with which the global technology sector came to a halt has put the brakes on rental growth almost universally," said Bill Rothe, senior executive managing director, CB Richard Ellis Global Research & Consulting. "While this is bad news for some real estate investors, it is great news for corporate tenants and their cost projections for real estate."

So why the turnaround? Rothe says that the pace of rental growth last year in many of the top markets worldwide, especially in North America, was clearly unsustainable and, if such rental growth had continued unchecked throughout this year, many markets were extremely likely to witness a far more catastrophic correction.

Avoiding a catastrophe, rather than simply a disaster, may serve as cold comfort to most in the real estate industry. But at least our friends at the U.S. Federal Reserve continue to try and turn the tide of their earlier tightness by lowering interest rates. Will lower rates keep real estate's boat afloat? Well, that depends on whose statistics and analyses you read today.

For more articles by Lesley Hensell, please press here.

Published: August 24, 2001

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