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A 'Goldilocks economy' for commercial real estate

More than five years since the official end of the Great Recession, this is shaping up to be a recovery for the ages — and for commercial real estate.

Certainly this isn't what anyone would term a "dream" recovery. The U.S. recovery is outpacing the U.K. and especially Europe but is still well off the typical pace of recovery after a recession. And even though GDP is growing, we're still not making up for lost ground at all.

Goldilocks and the three bears
Apic | Getty Images

And yet, scratch the surface of this seemingly ugly recovery and one sees a more attractive inner beauty to this expansion, particularly for the commercial real-estate sector: robust enough to fuel tenant and investor demand for property but not so strong as to overheat markets and induce unneeded speculative development. As a result, vacant space is filling up; albeit much slower than typical for the expansion phase of the cycle, but filling up just the same.

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All the key drivers for property demand are trending in the right direction:

* Housing markets are recovering nicely. Home sales, housing starts and pricing are rising in most markets.

* Jobs are back past prior peak levels and growing sharply. There have been more jobs gains in 2014 than in any year this century.

* Consumers, who make up more than two-thirds of the economy, are happy again because they're back at work, their debt levels are down and they've regained their wealth as home values and equity values are rising. All of which translates to more consumer spending.

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* Credit markets remain benign, with interest rates and inflation both extremely low due to the slack in the labor and commodity markets, which is a great foundation for both business and financial investment.

All of these factors are driving demand for all types of real estate, which means absorption is strong and growing for all sectors, even if it is below long-term averages, especially for a growth period. Plus, the best years are yet to come for this rebound.

Meanwhile, despite the strong demand, supply remains quite tame by historical standards. Construction is well below average rates and perhaps one-third to one-half of rates typical during expansion periods for all sectors except apartments — and even there, we are only now getting back to average rates.

The main reason: Despite recent gains in most sectors, both occupancy and rents remain well below prior peaks — and generally below the level required to support new construction. Which means that we can expect several more good years for property markets, as the surging property demand translates into rising occupancy and rents for existing properties.

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Of course, our economy faces some risks, though compared to where we've been, the risks are rather benign. They include:

* Foreign economic slowdown. This is now the biggest risk for the U.S., compounded by the surging U.S. dollar, both of which may limit our exports.

* Geopolitical turmoil. This seems a less immediate threat, though with potentially greater downside implications.

* End of the Federal Reserve's easy monetary policies. The timing and market reaction are still to be determined.

* How much longer can the recovery continue? The expansion already exceeds the post-WWII average.

But these negative risks are balanced by the benefits of lower energy prices and continued low interest rates, which provide important upside thrusts to the economy. Overall, the risk profile is more sanguine and the economic outlook more positive than it has been in many years.

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In sum, it was not a smooth ride to recovery, and for many households, it still doesn't feel very good. But for those of us in the property sector, this really is shaping up to be an outstanding expansion. And with all the drivers firing in the right direction and risks relatively tame, there's still a lot of road to run in this recovery.

You might even say that this is a "Goldilocks economy for commercial real estate" — not too cold, not too hot, but just about right.

Commentary by Andrew J. Nelson is Chief Economist | USA for Colliers International, a global commercial real-estate services company.