Commercial Real Estate Starts to Crack

The problems in the residential real estate market may be more spectacular, but the commercial real estate market (despite some pundits contrary opinions) has been slowly sinking.

The credit collapse has spread to the commercial market creating an almost complete unavailability of debt which has pushed up capitalization rates lowering values.This slow collapse has been under the radar till now simply because sellers refuse to sell at the offered prices. But re-financing needs will soon change the picture. Cheap short-term loans are coming due and buildings that were financed at 85-90% of value at LIBOR plus 1.0 to 2.0 are now looking at 65-75% loans to today’s lower values at LIBOR plus 4.0 if they’re good properties or in the teens if not. Even fully leased, cash-flowing properties may not be able support sufficent debt on today’s terms to pay off the existing debt.

Add the economic downturn to the credit crunch and you have tomorrow’s headaches.

Tumble! Manhattan Investment Sales Plunge in ’08
Cushman & Wakefield via The New York Observer – 1 July 2008

“Cushman & Wakefield today released its midyear report for the Manhattan commercial real estate market showing that the city’s overall vacancy rate has reached the bottom end of equilibrium level , the 7 – 9 percent range in vacancy where tenants and landlords are perceived to be on relatively equal footing in the marketplace…overall vacancy rate for Manhattan increased to 7.1 percent, up 1.8 percentage points from this time last year, and at its highest level since the third quarter of 2006…sublease vacancy rate increased to 1.5 percent, up 0.4 percentage points from the previous quarter and 0.5 percentage points from this time last year, a 50 percent increase…Despite the increase in vacancy, average asking rents continued to increase, albeit at a slower pace than one year ago. Overall asking rents for Manhattan reached $71.59 per square foot, up nearly 7 percent from $67.13 per square foot at the end of the first quarter of 2008, and up 21 percent from $59.17 per square foot at this time last year. Class-A asking rents in Midtown hit a new record at $92.30 per square foot…Average asking rents for sublease space increased 30 percent from this time last year, reaching $69.56 per square foot at midyear 2008, while asking rents for direct space increased 17 percent year-over-year, to $72.14 per square foot. This indicates that although both sublet and direct prices have risen, the sublet product now coming to the market is significantly more expensive than what was available one year ago…Year-to-date leasing activity…down 2 percent…advertising agencies have been the most active this year, accounting for nearly 20 percent of leasing activity year-to-date…Financial services accounted for only 14.1 percent of leasing activity, the second most-active industry segment at midyear 2008. Just one year ago, however, financial services had accounted for more than one-third of all leasing activity in Manhattan…

INVESTMENTS SALES

Manhattan property sales volume reached $13.8 billion for transactions closed and under contract through midyear 2008. At this time last year, $34 billion in property sales had closed or were under contract, which included $10 billion in two REIT privatizations…While values are down approximately 15 percent from the record peak in the first half of 2007, present values still reflect significant appreciation over the past few years…A lack of supply, coupled with the weak dollar, boosted foreign investor interest and activity in the first half of 2008. Year-to-date, foreign investment has accounted for more than 48 percent of investor dollar volume, a notable increase from the 12 – 15 percent level in recent years…

RETAIL

Though certain sub-markets remain strong, we are experiencing increased availability and a subsequent flattening or decline in retail rents in certain market segments…Two of Manhattan’s most prominent retail markets – Soho and Madison Avenue – exhibited divergent trend lines in the first half of 2008. In Soho, average ground floor asking rents increased 39 percent year-over-year, to $333 per square foot at midyear 2008, and availability remained relatively stable at 9 percent. Uptown, on the luxe stretch of Madison Avenue from 59th to 72nd Streets, the availability rate nearly doubled year-over-year, ending the second quarter of 2008 at 13.4 percent. During the same time period, average ground floor asking rents remained somewhat flat, up 8 percent to $1,107 per square foot…Moving to Manhattan’s Upper West Side, spanning 60th to 86th Streets on Broadway, average asking rents for ground floor retail space fell 9.5 percent from this time last year, averaging $316 per square foot at midyear 2008. Conversely, Fifth Avenue saw substantial increases in rent and decreases in availability. On Fifth Avenue, from 49th to 60th Streets, non-published asking rents for premier retail space hit $2,500 per square foot, clearly positioning Fifth Avenue as the highest-value retail corridor in the international marketplace….”

Businesses Take Less Office Space Nationwide
Wall Street Journal – Alex Frangos – 3 July 2008

“Nationwide, rents on office properties — including landlord concessions and discounts — rose 0.7% in the second quarter to $25.16 a square foot, the slowest growth since the second quarter of 2005, when the office market was just emerging from a half-decade-long slump, according to Reis Inc., the New York real-estate research firm…With inflation running roughly 1% a quarter, that rent growth is effectively wiped out…For the second quarter in a row, businesses vacated more office space than they took nationwide, a phenomenon known as negative absorption. The national vacancy rate edged up to 13%, from 12.8% last quarter…New York, which had double-digit rent increases in 2007 saw rent growth slow to 0.7% in the second quarter as financial firms slashed jobs. Big firms such as J.P. Morgan Chase & Co. and Lehman Brothers Holdings Inc. have put huge chunks of office space on the so-called sublease market, which adds to supply and depresses prices…The worst-hit areas of the country in terms of office space are those whose local economies are reeling from the housing-bubble burst. Orlando, Fla., Atlanta, Phoenix, Las Vegas and Sacramento, Calif., all saw rents decline in nominal terms, without accounting for inflation…Only 17 of the 79 markets Reis tracks saw rent growth outpace inflation. Among the leading cities was Houston, which benefited from the energy boom. Rents there increased 2.7% in the quarter to an average of $20.42 a square foot. Seattle and San Francisco also performed well. Los Angeles rents were up 1.4%, still healthy, but slower than the 2.8% growth it saw in the first quarter…”

Moodys/REALCommercial Property Price Index (CPPI)
Methodology developed at MIT’s Center for Real Estate – Monthly National All Properties Index – 24 June 2008 – via Economist’s View

The latest results of the Moodys/REAL CPPI show a decrease of 3% in April for the all properties national index.