Although many Americans classified the U.S. economy as poor in 2002, real Gross Domestic Product (GDP) in reality grew more than 3%. Moreover, the unemployment rate registered 6% or less in all but two months.

So, 2002 was by no means a true recession year. Nevertheless, most Americans — and many commercial real estate professionals — view the economy in a negative light.

Distorting Reality

There are five major reasons for the disparity between Americans' feelings about the economy and reality. First, the stock market continued to decline. Between January and December 2002, the Nasdaq composite index fell 31% and the S&P 500 fell 24%. Millions of investors thus suffered large equity losses.

Second, total job growth in 2002 measured less than one-half of 1%, compared with an average of 1.7% annually between 1992 and 2000. Third, several major economic sectors suffered severe recessions, including airlines, hotels and resorts, and telecom. Fourth, the war on terrorism — specifically the possibility of war with Iraq — caused a tremendous amount of general insecurity.

Finally, the commercial real estate industry as a whole experienced a true recession. Vacancies, especially in the office and industrial markets, soared at the fastest rate in history due to huge amounts of space being thrown onto the sublease market by corporate users.

Los Angeles-based CB Richard Ellis reports that the overall office vacancy rate in 50 regional markets measured 15.1% as of third-quarter 2002, vs. 12% in 2001. Vacancies in several markets topped 18%, including Atlanta, Columbus, Dallas, Salt Lake City, San Jose, San Francisco, Detroit, Jacksonville, Kansas City, St. Louis, Indianapolis, Phoenix and Portland.

The overall industrial vacancy rates in the 42 markets reported by CB Richard Ellis was 11.4% in the third quarter of 2002, up from 9.5% one year earlier. Regions with over 15% industrial vacancy rates included Atlanta, Austin, Baltimore, Ft. Lauderdale, Jacksonville, Las Vegas, Nashville, Sacramento and Washington, D.C.

Rising vacancy rates caused rents to fall sharply in most markets. But property sales showed bifurcated conditions. Buildings well-leased to good credit tenants with no imminent lease rollovers were in great demand from investors fleeing the stock market. But buildings with significant vacancies or high imminent lease rollovers could find few buyers, which reduced their values precipitously.

Return to Health

In 2003, the economy is expected to improve over 2002 if the U.S. is able to avoid a drawn-out conflict in the Middle East. In addition, the stock market and many depressed sectors are predicted to stabilize, although some major airlines may be drastically downsized.

Unfortunately, I do not believe conditions in commercial property markets will recover in 2003, although they probably will not worsen either. Even if the pace of economic growth increases in 2003, demand for office and industrial space will not expand much because so many firms already have excess space. Therefore, vacancy rates — especially in high-tech markets — will remain high throughout 2003.

In addition, investor demand for well-occupied properties could decline if the stock market revives significantly, which may occur if war in Iraq ends swiftly with a clear U.S. victory. Then many institutional investors who opted for real estate over stocks may return to that market, especially if conditions in space markets remain poor.

Anthony Downs is a senior fellow at the Brookings Institution in Washington, D.C.