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  Posted on: Thursday, April 23, 2009
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Next Shoe to Drop---Commercial Real Estate

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Although we have discussed commercial real estate many times in our comments over the past few years, we have never devoted the whole comment on the subject.  However, we are so concerned about the health of this segment of the economy we thought we should fully address it. The commercial real estate market has already dropped by about 16% since late 2007 and we expect it to continue declining throughout 2009 and probably well into 2010.


Commercial real estate is very dependent upon employment and we expect the loss of jobs to continue this year and next.  There have already been over 5 million jobs lost since the recession (or maybe depression) starting in November 2007.  The four main areas of commercial real estate are apartment dwellings, retail outlets, office buildings, and industrial facilities.  Seventy percent of renters of apartment dwellings are between the ages of 20 to 30 years old, and this is also the same age group of the highest lay offs.  The rising unemployment will clearly restrict the consumption needed to keep retail outlets prospering and naturally the layoffs will increase the vacancy rates of office buildings and industrial plants. 


We will continue to advise our readers on updated trends and forecasts of rent, vacancy, and inventory for apartment, retail, office and industrial properties in up to 169 metropolitan areas and more than 1,800 submarkets and neighborhoods.  We will be using Reis, Inc. which is one of the most trusted providers of impartial commercial real estate performance information for more than twenty-five years.  Thousands of commercial real estate professionals at hundreds of institutions-banks, lenders, investment banks, insurance companies, investors, and developers-rely on Reis data to support their critical investment decisions.  We will attempt to get the latest commercial real estate data to you quarterly.


The nation's apartment market deteriorated in the first quarter as rising unemployment dashed hopes that the housing downturn would create a soft landing by bringing former homeowners back to the rental market.  The vacancy rate for the top 79 markets jumped to an average 7.2%, a full percentage point over the past two quarters and the highest level since the first quarter of 2004.  The vacancy rate in 2006 was 5.8%.  This jump in vacancies came even as asking rates (excluding concessions) were reduced by 0.6%, the largest fall since Reis's records (1999).  Effective rents, or the rents that landlords actually collect, fell 1.1% in the first quarter to an average of $984/month. "For landlords to actually lower both really shows how bad it is," said Victor Calanog, director of research for Reis, "They're willing to offer you lower rents before they even start negotiating and offering incentives."  Reis is forecasting rent declines of as much as 2% for the year and a vacancy rate that tops out at about 8%, the highest level since the late 1980s.  These rising vacancies appear to be pushing more apartment owners into delinquency.  Among commercial mortgage-backed securities, the multifamily sector posted the highest delinquency rate in February, reaching 3.3% from 3% in January.


The rents fell the sharpest in markets that saw heavy losses in the financial-services sector, posting declines of more than 2% in New York, Long Island, San Francisco and San Jose.


The retail segment of commercial real estate was also "on the ropes".  The amount of occupied space in U.S. shopping centers and malls declined a net 8.7 million square feet in the first quarter of 2009.  The amount of occupied space in U.S. lost in that one quarter was more than the total amount of space retailers gave back to landlords in all of 2008 and any other year in recent history, according to Reis.  Victor Calanog said "the rise in unoccupied space is from tenants cutting back or going out of business. Space is given up, it's not like there's a huge number of projects coming on line that can't find tenants."


The decline in occupied space pushed the vacancy rate for malls and shopping centers in the top 76 U.S. markets to 9.1% in the first quarter from 8.3% in the previous quarter.  The vacancy rate, which began rising slowly in 2005 then accelerated in 2007, is now at its highest rate since the early 1990s.  The rates continue to go up even as landlords make cuts to their lease rates in an effort to retain and attract tenants.  Mall lease rates slid 1.2% in the first quarter and those at shopping centers, a category that includes strip centers and other open-air centers with common parking lots, fell 1.8%. 


This contraction is sapping the cash flow of retail-property owners, making it tougher for some to make interest and principal payments on debt.  The delinquency rate among the $208 billion in securitized mortgages on retail properties stands at 2.1%, up from 0.3% a year ago.  The other categories of commercial real estate are just as bad as these two-we may discuss them next week.  There is also about $300- $500 billion of commercial real estate debt coming due this year and over $814 billion coming due over the next two years.  Another source on the CMBS is Jeff Doboer, President and CEO of the Real Estate Roundtable, who confirmed that the total CMBS have $1.2 trillion maturing during the year 2010-2012.


Although Reis seems to think that the problems in commercial real estate will end later this year, because of the present restrictions on credit and maturing debt, we expect the turmoil to continue well into 2010.    

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