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.
Photo Credit: strangelv
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