The commercial real estate market is likely to take an even bigger hit this year and may continue its decline into 2010 due to drastic job losses, even though the market has shown only moderate declines so far, says Grubb and Ellis, a real estate and investment firm.

Declines in commercial real estate often lag as much as six months behind the economy, and companies may not have had time to react to the shrinking labor market yet, the company said in a recent report.

At the end of 2008, U.S. office vacancy rates were 14.8%, but may hit 16.5% to 17% by the end of the year. By early next year it could surpass the high of 17.9% that was set in early 2004, Grubb and Ellis predicts.

The office construction pipeline contained 90 million square feet at year-end 2008, the lion's share of which will be delivered in 2009, according to Grubb and Ellis' Investment Opportunity Monitor. This combined with a projected 45 million square feet of negative absorption, including a big jump in sublease space, will push vacancy up by two percentage points by the end of 2009. Tenants will have greater negotiating leverage this year, the report continues, with concession packages becoming more generous as the year progresses. The growing inventory of sublease space will put downward pressure on asking rental rates for direct lease space, which are expected to decline in the range of 4% to 5% for both Class A and B space by year-end.

Washington, D.C., should be at the top of office investors' buy list, according to the report, because it will benefit from the credit crisis as the government expands to implement its economic recovery plan.

The other office markets in the top 10 are Portland, Ore.; Los Angeles; San Francisco; Austin, Texas; Dallas-Fort Worth; Houston; Raleigh-Durham, N.C.; Boston; and Oakland, Calif. The Texas markets offer strong population growth, while the others offer strong population growth as well as natural barriers to entry.

Meanwhile, the industrial space market should recover more quickly than the office market because its construction pipeline will thin out sooner, says Robert Bach, senior vice president and chief economist of Grubb & Ellis. Still the vacancy rate is expected to rise by 60 basis points and reach 9.4% by the end of the year, the report says.

The multifamily market probably will see the smallest decline because some positive forces will mitigate the effect of negative ones. Apartments are seeing some new renters who have lost their homes to foreclosure, while landlords are able to maintain existing renters who are waiting for prices and mortgage rates to fall further, the report says. However, new graduates who can't find jobs are doubling up with a roommate or moving in with a relative to conserve cash. At the same time, the apartment market faces competition from an increasing supply of unsold condos and foreclosed homes returning to the market as rentals. The negative forces are expected to have a slight edge in 2009 resulting in slowly rising vacancies for the multi-housing market this year.  

Of the top 10 apartment markets in Grubb & Ellis' Investment Opportunity Monitor, seven are on the West Coast and three are on the East Coast. All offer barriers to entry, good economic prospects and high home prices. Los Angeles ranks first followed by San Francisco; Orange County and Oakland, Calif.; Washington D.C.; San Diego; New York City; San Jose, Calif.; Long Island, N.Y.; and Portland, Ore.