Some New Perspective on the Commercial Real Estate Market….Please!

by CoyDavidson on December 30, 2009

Over the past several months, I have watched countless videos from Fox News, CNBC, and other media outlets covering the impending doom of the U.S. Economy as a result of troubles in the commercial real estate market.

  • Is Commercial Real Estate the Next Shoe to Drop?
  • Commercial Real Estate Bubble Bursting?

Can we get a new tag line please! Talk about over used phrases.

he primary focus of the media’s coverage has centered around the mass volume of commercial real estate debt that has to be re-financed over the next several years and the challenges the owners of commercial real estate face in doing so where the value of their properties have dropped 30 to 40 percent. Yes, absolutely this is a huge issue if  an owner’s existing debt now exceeds the market value of the property.

So the two big questions are; what are the banks, insurance companies and pension funds that hold the notes to these properties going to do? What role is the federal government going to play?

So far the approach has been a “wait and see attitude” or a strategy that his been coined “pretend and extend”. (That is heavily over used phrase number 3). The latest figure that has been repeatedly thrown about is that commercial real estate values are now at 2002 levels. (more on that later).

In my opinion, the real question is when are the leasing fundamentals going to improve? The value of commercial real estate is driven by rent  and occupancy levels. Real Estate values are heavily supply and demand driven. One thing is for sure, we will not see any significant amount of new supply coming on-line in the next 24-36 months.

  • As consumer confidence improves the  U.S. consumer will increasingly spend and retailers will begin to add space in shopping centers and  build new locations.
  • As manufacturers see more demand for their products, they will increase inventory and  warehouse and industrial space
  • When job growth returns, then office tenants will take more space driving up occupancy rates and rental values.

So when will leasing fundamentals begin to improve? There are economic indicators that have surfaced in the last couple weeks that suggest the early signs of improvement in leasing fundamentals. So if this is the case then it really becomes an issue of velocity. How fast can the real estate markets recover? This is the answer the federal government and the real estate lenders holding the commercial real estate notes wants answered before we see a clear policy about how to address the debt markets.

What about Houston the Houston Office Market?

I don’t believe office property values are off 30-40% in Houston. While they certainly may be down to a lesser degree as a result of higher capitalization rates required by investors. As a result of so few properties changing hands in 2009, I don’t think anyone really knows. However, you will be hard pressed to find a Houston office building owner to sell you his property at 60 to 70% of 2008 values without being in a severely distressed situation. Furthermore, for building owners, unless they have signed or re-structured several leases in 2009, the majority of  their tenants likely signed leases in the period of 2005-2008 at the market’s peak and have yet to roll.

In terms of rental rates, asking and effective rents have not decreased more than 5%  in most submarkets over the past year and are  no where near 20o2 levels. We might see the overall vacancy rate increase maybe a 100-150 basis points in 2009. Houston has a 200 million square foot office market, to see 2 million square feet of office space vacated is surely significant, but is not a severe blow to the market.

So what does this mean for office tenants?

  1. If owning a building a makes sense for your company, then this might be a good time evaluate purchasing a building. The best candidate building might be the one you currently occupy, particularly if you are a large tenant and your occupancy represents a substantial portion of the buildings rental income.
  2. There will be select acquisition opportunities, but very few at 60 to 70% on the dollar.
  3. 2010 presents a window of opportunity to lock into better rental rates over the long term before leasing fundamentals improve significantly.

So my focus for 2010 is to assist my clients in taking advantage of  the market opportunities that exist while the window is still open. I believe that if you are confident enough in the direction of your company’s business going forward, whether you want to own a building or continue to lease, now is the time make your real estate a key part of your strategy for success in the next several years.

In the meantime, I will let the  building owners, lenders, politicians and mortgage brokers solve the commercial real estate debt crisis. I am sure the media will continue to talk about it until they do. Hopefully they will come up with a new tag line or two.

My prediction for the next over used phrase on this subject: “The de-leveraging of commercial real estate”.

  • Coy, awesome post! You are right on the money, but that “deleveraging” phrase is ALREADY overused in many circles.

  • CoyDavidson

    Ben, thanks for the comment . Randall Zisler in this video coined it a “Darwinian Herd Thinning Event” I am guessing that is not going to become an over-used phrase.

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