Theme from the Bottom - Part Four

We’ve written in the last few entries about oversupply and its causes (namely, Demand Overestimation, Optimism Bias and Strategic Misrepresentation). We even found a timely example of those themes in David Lereah’s confessed divorce from the so-called “positive spin.” Lereah, as you may recall, was chief economist for the National Association of Realtors.

Today, we find a related but more practical take on the impact of oversupply and market disequilibrium in the commercial environment here in Southwest Florida. The title of Mark Alexander’s Commercial Connection article in the News Press this week was Market for office space follows the job market: Current high vacancy rates favor tenants. For those who don’t know, Mark Alexander, CCIM, is senior medical office adviser at Sperry Van Ness in Fort Myers.

Mr. Alexander’s thesis – that it’s a buyer’s/tenant’s market in the commercial market in SWFL – is sound because, as he notes and as we’ve discussed, there is a terrific oversupply of commercial space. This is the practical portion and should not be too striking a proposition. Based on the market forces, buyers and lessees of commercial space should be able to negotiate a pretty good deal.

Theoretically, I am more interested in the cause(s) of the oversupply. Mr. Alexander cites the downward employment spiral as one major cause (“The office market follows the job market”). He explains that when employment was on the rise (2004-2006), demand rose concomitantly and “developers . . . planned more office buildings to construct and keep pace with this glorious rising demand.” This planning is typically on a two-year cycle, so developments planned during the end of the employment rise in 2006 would have been scheduled for occupancy in 2008. Unfortunately, the fall in employment has left many of those developments unoccupied (Mr. Alexander gives a very thorough look at the percentages of vacancies in the area, worth taking a look at if you are interested in the ratios and what constitutes equilibrium and a disturbance thereof).

One can not discount the impact of employment on the commercial market. But, as we have discussed, there are other forces (namely, demand overestimation, strategic misrepresentation and optimism bias) that contribute to oversupply. How, then, do we monitor these forces in order to make better planning decisions in the future? Mr. Alexander says only that maintaining “the supply and demand balance for office space can be tricky [because developers] typically need close to 2 years to finish an office building once they commit to a project.” “Tricky” is probably a purposeful understatement because going further would have been beyond the scope of the article. That said, future development due diligence would benefit from exploring market forces beyond employment.

I would be interested in learning from you developers or commercial professionals what factors are considered during the planning stages to best estimate (it is, after all, always an estimate) rates of occupancy two years out.