by Calculated Risk on 4/30/2007 04:01:00 PM

From Bloomberg: U.S. Office Vacancy Rates for the First Quarter

The U.S. office vacancy rate rose in the first quarter, according to CB Richard Ellis. ... The rate was 12.8 percent in the first quarter, up from 12.6 percent the previous quarter. The rate was 13.6 percent a year ago.

Is this the beginning of the end for CRE? Let's connect a few dots:

1) Non-residential structure investment has been booming for the last few years. Commercial rents have been rising and office vacancy rates have been falling.

2) However, in the typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for four straight quarters (following two minor declines). So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

3) The WSJ noted earlier this month that demand was "sluggish" for office space. The current office space absorption rate is about 8 to 10 million square feet per quarter, but "... developers will open 76 million square feet of new office space by the end of this year." Since supply will grow significantly faster than the absorption rate, vacancy rates will rise.

4) Many banks are over-exposed to CRE lending. With rising vacancy rates, defaults will probably start to rise for CRE loans.

And remember, non-residential investment is the great hope of the soft landing view. That is why many economists are watching non-residential investment closely. From Professor Hamilton: Consumption smoothing and economic slowdowns

... the key thing to watch is nonresidential investment. I was very worried when this had made a negative contribution to 2006:Q4 GDP growth, and relieved that its contribution to 2007:Q1 is back into positive territory.

And from Paul Krugman at the NY Times: Another Economic Disconnect. (Note: Excerpts are available at Economist's View).

... with housing still in free fall and consumers ever more stretched, optimistic projections for the economy depend on vigorous growth in business investment. And that doesn’t seem to be happening.

And if office vacancy rates continue to rise, combined with a significant increase in supply coming this year and next, a further reduction in business investment (especially for structures) is probable.