A rebound in economic growth and job gains over the next year, coupled with an expected retreat in oil prices and strong business spending in the second half of this year, is setting the stage for improvements in commercial real estate, according to the National Association of Realtors Commercial Real Estate Quarterly.

David Lereah, the association's chief economist, said there already is a strong flow of capital into commercial real estate. "This optimism by investors says more about the future of the commercial real estate sector than anything else," he said. "The investment level shows they understand the value of portfolio diversification and the fundamental demand for commercial real estate that occur in a growing economy."

More than $99 billion in commercial sales took place in 57 tracked metropolitan areas during the first eight months of 2004, up from $54.6 billion during the same period in 2003. This includes a 66 percent increase in the purchase of office buildings and a 40 percent rise in multifamily property transactions.

Commercial investment broker Michael Shields of Coldwell Banker Commercial in Cupertino shared the latest news on the local multifamily, retail, office and industrial markets.

"The retail market will continue to remain red hot. The demand for retail properties has driven prices up and cap rates down. Indeed, I can't keep any retail product in inventory," said Shields. "Brokers, myself included, have been able to sell retail listings very quickly, sometimes with just a few phone calls. These properties are sold principally based upon their investment value."

In the multifamily arena, Shields believes the market will probably continue to be robust. In spite of lower incomes, property values have not declined proportionately as expected since income property is valued based upon the income stream. Shields says there is a strong demand for smaller properties of four to 10 units and he is seeing many people opting to invest in real estate rather than in the securities market.

"There has also been an enormous influx of immigrants to Santa Clara County. Many of these people, who may come from different cultures, strongly believe in investing only in 'bricks and mortar.' The combination of the shift in capital market investment strategies and new property owners means that both the residential and multiresidential market have benefited in price appreciation," Shields said.

Calling it a simple matter of supply and demand economics, Shields adds, "Many longtime owners of properties are selling and either buying larger properties or different property types altogether, such as leased investments."

One area that is destined to pick up when the local economy turns around and companies begin hiring again is the office market. There are more than 25 million square feet of available office property from San Jose to San Mateo still available, and prices remain at all-time lows. Shields says there are many bargains for both leasing and purchases of this type of property.

Industrial is another product type that continues to be popular in spite of the lackluster economy. Shields believes low interest rates are the key to the strong investment market.

"We are seeing many companies purchase properties rather than leasing them. The larger properties are moving considerably slower than smaller ones, which are being gobbled up by owner/operators benefiting from the lower interest rates," Shields said.

Nationally, more than 45 percent of overall commercial spending this year has been on acquisition of investment-grade office buildings. Private national and local investors accounted for 47 percent of transaction volume, publicly traded real estate investment trusts represented just over a quarter of the total, and institutions made up 11 percent. Foreign investment totaled 7 percent of commercial transactions and private real estate investment trusts 5 percent; other categories were less than 4 percent.

National Association of Realtors President Walt McDonald said declining vacancy rates are behind the optimism in commercial investment. "Commercial market vacancy rates have been steadily declining due to the growing demand for space," he said.

"It looks like we'll see an acceleration in the demand for space over the next year with declining vacancy rates in the office, industrial and multifamily sectors."

Net absorption of office space, which includes leasing of new space coming on the market as well as space in existing properties, should total 45.3 million square feet this year, up from only 20.0 million in 2003. Vacancy rates in the 57 markets tracked are projected to decline 0.3 percentage points to 16.3 percent in 2004 and drop to 15.0 percent next year. Office rents are expected to rise 1.4 percent in 2004 and another 1.9 percent in 2005.

In the retail sector, net absorption is seen at 22.1 million square feet in 2004, compared with 11.8 million last year. The average vacancy rate for retail space in the 57 metro markets is projected to be fairly stable at 8.2 percent this year compared with 8.1 percent in 2003; vacancies are seen at 8.1 percent next year. Retail rents are forecast to rise 3.6 percent this year and another 4.2 percent in 2005.

The industrial market continues to be impacted by additions to inventory, especially through the build-to-suit process. Net absorption is projected at 97.4 million square feet this year, up from 16.5 million in 2003. Because a large volume of new space has come on the market, the national vacancy rate is expected to average 11.7 percent this year, close to the 11.6 percent rate in 2003, and then slip to 11.4 percent next year. Industrial rents should decline 1.3 percent in 2004 and essentially hold flat in 2005.

The apartment rental market—multifamily housing—is expected to see a net absorption of 260,000 units in the 57 markets tracked during 2004, compared with only 159,400 last year. The average vacancy rate is expected to be 6.2 percent this year, down from 6.4 percent in 2003, then easing to 6.0 percent next year. Average rent is forecast to rise 1.2 percent in 2004 and another 2.2 percent next year.