Is This the Bottom for Commercial Real Estate Prices?

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Even the most bearish economist is predicting that commercial real estate prices will fall up to 40 percent from peak to trough. However, the data released yesterday from Moody’s Investor Service shows that in April commercial property prices plummeted a record 8.6 percent. According to Moody’s data, commercial property prices fell a total of 29.5 percent from their highs in 2007. This leaves another 10 percent drop in prices if the most bearish economists are correct. In my opinion, much of this drop was due to a speculative credit bubble that caused commercial property buyers to purchase properties that would never produce a positive cash flow, even assuming a strong economy and strong demand for commercial real estate.

I believe that most of the declines in commercial property prices that can be attributed to the credit bubble have mostly taken their toll on prices. But, I surmise that we could experience an even greater decline in commercial property prices due the fact that the economy is fundamentally unsound. If one closely examines the fundamentals of supply and demand for the commercial property sector, the prospects for continued price declines becomes readily apparent, especially in the retail and office building sectors of commercial real estate.

Background to a Crisis

During the speculative credit bubble, developers built many more office buildings and retail stores than could possibly be sustained. Now that unemployment is in the double digits and major economic sectors like the automotive industries are going bankrupt there is less demand for commercial property. There have been many large, well known, retail brands either going bankrupt or severely cutting back growth projections. In a small city, near where I live, there are at least fifteen Starbucks. How many Starbucks stores can one small city support? Circuit city is out of business, Brandsmart may be next. Car dealerships are closing their doors around the country. These are all commercial real estate tenants whose absence can’t easily be filled. The list goes on and on. If so many large retailers are going out of business or curtailing operations then there will be even less demand for all of the vacant commercial retail space.

Commercial Real Estate Breakdown & Predictions

As local, state and federal governments go deeper into debt they will be increasing taxes even further on businesses and property owners. This means higher taxes for the owners of commercial real estate. If the costs to hold a property increase, then its intrinsic value must decrease.

I would challenge the 40 percent figure and would argue that prices could drop even more due to the dismal state of the economy at large. I would go the record to say that the commercial property sector could see real price declines of up to 70 percent from peak to trough. The worst might still be ahead of us.

Source: Reuters
Photo Credit: strangelv

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  1. Approximately one in eight mortgages nationwide are currently in some stage of default or foreclosure. None of these houses are on the market yet, but it’s a safe bet that almost all of them will be eventually.

    Second, there is a massive wave of Alt-A and Option-ARM mortgages that are due to reset/recast starting later this year, lasting through all of 2010 and 2011, and into early 2012. Option ARMS are mortgages that permit the borrower to pay even less than the interest owed, let alone any principal. The shortfall is added to the balance. Once the balance reaches 125% of the original loan, or a certain time (3-5 years into the loan) is reached, the payments jump to become fully amortizing, which will often double the payment due or worse. Alt-A loans are also known as “liar loans” because they were taken by borrowers who were not required to provide any evidence of their income or assets. Both types of loan were very widespread in the Bay Area.

    We ain’t seen nothing yet.

  2. There are attractive opportunities for existing independent retailers or prospective new retail ventures to secure outstanding retail space at very attractive rents. Landlords who previously wouldn’t even talk to independent retailers are suddenly much more flexible. Don’t be afraid to ask for exactly what you need to make the deal work, and don’t hesitate to walk away if you don’t get it. If you work the market, you’ll find the space you need at rents and terms that work for you.

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