Projecting Future Market Conditions

You have probably all read real estate market reports that analyze statistics and show graphs and charts tracking commercial real estate rental and occupancy rates. However, most of what is published is tracking historical information and information that provides “asking rates”. While interesting and somewhat helpful, occupiers of commercial space consistently ask what the future market conditions are going to be, only to hear their broker say that currently they think the market could decline by a few dollars a foot over the next 18 months until stabilization occurs. How much better would the response be if they would actually provide you with some of the same metrics they use to illustrate what the market has already done in order to show what they believe will happen in the future? This will allow corporations to make important decisions regarding their real estate using statistical data rather than just a “gut feel.” This is exactly what AQUILA Commercial has been doing with our Comparable Trend Analysis and Vacancy and Rental Rate Forecasting Analysis. Below are a few examples:

Below is a vacancy forecast for the Northwest submarket (Austin’s largest). The red line represents the historical vacancy rate while the purple line is the vacancy rate we are predicting through the end of 2011. We see positive absorption as far as the model predicts, and since there will be no new buildings being built in the foreseeable future, there is a 95% chance that vacancy rates will decline from where they are now at 26% to anywhere between 17%-22%. Declining vacancy rates do not mean an automatic increase in rental rates, as rental rates historically lag vacancy.

Many factors highlight the downward trend in vacancy rates, most notably job growth. While vacancy rates typically provide a great indication for the direction of quoted rental rates, quoted rental rates can also be predicted to some degree by the change in the difference between quoted rates and the rates at which deals are actually being signed (“The Spread”). When the Spread is at its peak, typically it indicates that quoted rental rates are close to their lows. When the Spread is at its low, typically it indicates that quoted rental rates are reaching their peaks. The chart below highlights this inverse relationship and the notion that the Spread usually hits its peak or low several months or quarters prior to an increase or decrease to the quoted rental rate. We predict that the Spread is near its peak which suggests Landlords will soon begin to scale back the concessions they are giving, narrowing the Spread between actual and quoted rates and soon after increasing the quoted rental rates.

Given the information from the previous charts and the economic indicators we appear to be faced with in the future, AQUILA is in a position to advise clients on the most probable outcome for rental rates over the next 18 months and beyond. The graph below displays our rental rate forecast for the Northwest submarket (red line) compared to historical rental rates (blue line). The green line is AQUILA’s prediction as to where the Northwest submarket will be in the following six quarters. As previously mentioned, we are predicting that rental rates will continue to decrease until the middle of 2011, when we will see rental rates begin to tick upwards.

There are many other non-quantitative factors that can drastically affect the market. For instance, the way that banks will handle the current credit crunch with regards to commercial assets that they have foreclosed on can affect the Northwest market in a big way. If they decide to “fire sale” these assets to increase their liquidity, the new owners will have a lower basis, which would allow them to do deals at much lower rates. This could then force the rest of the market to follow suit to be competitive. However, if the banks decide to hold on to these assets for an extended period of time and they sell for a premium when conditions improve, it could have a reverse affect and influence the market upward.

New governmental regulation may also affect how companies approach their real estate. There is legislation currently being discussed that may require companies to capitalize their lease obligation. If this happens, we may see more companies trying to buy buildings because they will already be accounting for it on their balance sheet. This could inflate the value of some assets as the pool of buyers will increase with potential owner-occupants, who can typically pay more for a building than an investor. Ultimately, as values increase, rental rates will also increase as there is a direct correlation.

As you can see, there are many more sophisticated ways to predict future market conditions than with just a “gut feel.” With the proper foresight and strategy, your company can capitalize on market conditions to see substantial savings while mitigating risk.

If you would like to understand how future market conditions will ultimately affect your company or if you’re interested in seeing these same models for the other submarkets, please contact Craig Couch or Jay Lamy at 512-684-3800. Feel free to visit us at www.aquilacommercial.com. We look forward to hearing from you.