Has the recovery of real estate fundamentals finally lost its oomph? According to Boston-based Property & Portfolio Research (PPR), the pace of year-over-year vacancy declines slowed down across all four major property classes last year. To be sure, the national market closed out the year with tighter all around vacancy. But PPR believes that last year’s smaller vacancy drop versus 2005 suggests that the best part of the real estate recovery is over.

Given the numbers, it’s easy to see that occupancy growth last year fell short of the 2005 performance. The retail and warehouse markets posted the sharpest slowdown in vacancy declines, and that contrasted sharply with each sector’s performance in 2005. PPR data shows that the U.S. retail market saw vacancy drop by just 0.5% in 2006, or less than half the 1.4% decline it posted in 2005. For the warehouse sector, which has been hamstrung by the weak housing market, 2006 brought a small 0.3% vacancy decline versus a 1% drop the year before.

Nor is PPR the only research outfit that’s skeptical about the momentum behind this fundamentals recovery. Craig Thomas, senior vice president and director of research at Boston-based CBRE Torto Wheaton Research, believes that new supply will increasingly become a factor over the next few years — and that should keep vacancies from dropping.

He points to markets like California’s booming Inland Empire region where industrial supply has shot up to accommodate perceived demand. Thomas admits that fundamentals are healthy enough to absorb some of this new supply, but he also sees this new space making it harder for vacancy rates to drop and rents to climb. “We are not having a construction boom like we did in the mid-1980s,” says Thomas. “But there are still plenty of cranes in the air all over the country.”

The largest vacancy decline in 2006 was posted in the office sector, where vacancy fell by 0.9% to end the year at 15.3%. But even that drop was lower than the 1.2% decline that the office market posted in 2005. Like the warehouse market, it seems, one concern for the office sector is a growing pipeline of new supply. According to the PPR report, 2006 completions were more than 40% above those in 2005.

The effect of limited condo conversions was keenly felt in the apartment market in 2006. With demand growth thinning out to half of the 2005 level due to a moderating economy, the apartment sector posted a meager 0.1% vacancy decline in 2006. The previous year, when condo converters removed more than 2% of total apartment inventory from the market, the apartment market saw vacancy decline by 0.5%.

Based on this data, some general conclusions can be reached. Vacancies will not only continue to flatten, but they may actually increase in some property classes over the next few months. The one exception is the apartment market, which should benefit from growing demand in 2007 as people await the housing market bottom.

To that end, PPR expects that the apartment market will end 2007 with lower vacancy. Not so for the office market, where limited new demand and rising supply should push vacancy up. Meanwhile vacancies should increase in the retail and warehouse markets in the coming year as demand shows signs of strain.

“More investors are buying for the income component of the property rather than just planning to flip the asset,” says Thomas, CBRE Torto Wheaton Research. “That’s good to see, but it also makes [the investors] more sensitive to new supply.”