'Small' investment has significance for industry

Despite national reports pointing to continued weakness in major commercial real estate markets and the persistent talk of a jobless recovery, interest in commercial real estate and commercial mortgages is riding high.

Evidence of this trend came last week when it was reported that Vanguard Funds invested some $300 million in commercial mortgage-backed securities for the first time.

Vanguard, which runs the largest mutual fund, has many stock and bond funds, and the relatively small investment probably fits nicely into one of the bond funds. But a small investment for Vanguard symbolizes a much larger trend for commercial real estate; the investment class is becoming mainstream, like corporate bonds or stocks.

More big buyers like Vanguard interested in commercial mortgages means that rates charged to borrowers can stay low. Indeed, commercial mortgage rates responded to the heightened demand during the past 30 days by compressing slightly. According to the Barron's/John B. Levy & Co. National Survey, rates for commercial mortgages now range from 4.85 percent to 5.85 percent for 5- and 10-year terms. These low rates have helped real estate prices reach nose-bleed territory at the same time markets are bottoming.

Office market down

Last week, REIS Inc, a real-estate research firm based in New York, published a survey indicating that the national office market continued to deteriorate in the third quarter with vacancies rising 0.2 percentage points to 16.8 percent, while average rents fell from $21.03 to $20.85 a square foot in the top 50 U.S. markets.

Simultaneously, REIS issued a nationwide apartment market survey indicating that vacancies fell 0.1 percentage points to 6.6 percent in the top 50 U.S. markets. This tightening in occupancy occurred at the same time that average rents increased from $854 to $856 a month.

The third-quarter levels are stronger than last quarter, but still weaker than a year ago when vacancy was 5.9 percent and average rents were $859 a month. This slight uptick in the strength of apartments coincides with a Labor Department report that indicated September job production was greater than job losses for the first time in seven months.

Locally, more homeowners

In Richmond, the jobless recovery is not as evident. In fact, as of July, before jobs created by the opening of Short Pump Town Center and Stony Point Fashion Park are counted, Richmond had added more than 3,000 jobs since July 2002. While job creation has helped new apartments get filled, low interest rates have lured more potential apartment dwellers into the ranks of homeownership.

Real Data, an apartment research firm based in Charlotte, N.C., reports that the average vacancy rate in Richmond declined to 8.8 percent in July from 9.2 percent in January, but the vacancy rate in July 2002 was a much stronger 6.5 percent. Meanwhile, average rents have risen to $683 a month from $676 a month a year earlier.

The first thought is that too many new apartments have oversupplied the market, leading to higher vacancies. That is not the case. The year-to-year comparison is based on virtually the same number of apartments, only in July there were 4,045 vacant units compared with 3,008 a year earlier.

Interestingly, apartments less than 5 years old are in demand, showing a vacancy rate of only 5.9 percent vacancy with average rents moving from $820 a month in July 2002 to $825 a month a year later.

Andrew Little is an investment banker with John B. Levy & Co.