Deficit Plan Could Drastically Affect Commercial Real Estate

The President’s Deficit Commission has recommended spending cuts that could drastically change commercial markets in Washington DC and other major cities.

The government is a major tenant in many large cities and the Commission has recommended cutting up to 10 percent of the federal workforce which accounts for roughly 200,000 jobs. In order to understand the amount of space that represents, let’s say that there is an average of 180 square feet per employee which covers executive offices, conference rooms, desks, cubicles etc … it makes the total square footage around 36 million. Additionally there are calls to cut tens of billions from defense spending which would add additional empty space.

Washington DC would likely be the hardest hit area since it has the highest proportion of federal employees but other major markets would be adversely affected. Obviously any cutbacks would be phased in over time but the loss of quality tenants would hurt landlords and lets not forget that this would add to the unemployment roles.

Hopefully the government does its homework before making any drastic decisions but its obvious that any solutions to the budget gap will be controversial but need to be made to preserve our financial future.

Moody’s: Commercial Property Prices up 4.3% in September

According to research firm Moody’s, prices for commercial property increased 4.3 percent in September but prices remain more than 40 percent off their peak reached in October of 2007. The increase was the highest ever in the decade that the firm has been tracking prices and represents a growing confidence in the recovery by firms who are in a position to acquire property. However the numbers are somewhat skewed because of high sales prices for landmark office properties and do not necessarily reflect the entire market as a whole.

Even with the increase in prices, vacancy rates remain high throughout the country and are not expected to see a significant decrease in 2011.

NAR Claims Commercial Vacancies Hitting Their Peak

The National Association of Realtors said that it expects the commercial vacancy rate to peak at 16.7 percent before it starts a gradual decline over the next year. The commercial real estate sector has dragged down GDP in 9 of the last 10 quarters and its decline continues to impede the overall recovery. However improving market conditions and moderating trends in both rents and vacancy rates have given hope that the market’s woes are beginning to crest.

According to this report, vacancies will remain high but won’t approach the levels seen in the early 1990s when commercial vacancies spiked to even higher levels as a result of overbuilding.

Palin Reportedly Looking for Office Space in Iowa

The rumors that Sarah Palin will run for president in 2012 will certainly be more credible based on recent reports that Palin’s team is looking at office space in Iowa as well as other logistical support components. The presidential rumor mill continues to churn out new stories but no single candidate can produce a more “Apple” reaction than rumors regarding Palin.

Palin is a polarizing candidate but she also has high favorable ratings within the Republican ranks and could surprise those who are already saying she can’t win. Anyone want to handle the tenant rep for her? : )

Lawmakers Compete for Office Space in Austin

Its that time of year when state house elections create a new set of representatives to replace those who lost or have decided to retire. Besides orientation, making acquaintances and trying to get on committees, one of the oldest and most competitive arenas is deciding who gets what office in the Capitol. Senior representatives get first dibs on prime space which is normally in the main building itself so they are walking distance to other movers and shakers.

That leaves all of the new faces competing to get what they can which is normally available space in the underground extension of the Capitol. As someone who has toured the Capitol, I wish them the best of luck because its going to be a crowded two years if you’re on the short end of the stick.

Thankfully finding office space for businesses is much easier and a little less competitive.

New Projects Revitalizing Downtown Tucson

Four new projects are revitalizing downtown Tucson in what is known as their SoCo (South of Congress) district. Arizona has been hit hard by the recession and a Moody’s analyst recently stated that the state may go back into a recession. Revitalization projects like these are crucial to sustaining economic growth because they bring spending and investment into the local economy and all four are privately financed as opposed to public financing.

The four projects are:
- Construction of the UniSource headquarters which adds 170,000 square feet of office space, first level retail and green initiatives
- 44 E. Broadway which is a redevelopment of a foreclosed property and will add office and residential space
- 50 E. Broadway which offers office and restaurant space
- 135 S. Sixth which offers a new restaurant by renowned chef Janos Wilder

Even when jobs return commercial demand will slack

October is being projected as another month of limited job creation and we aren’t seeing signs long-term hiring will improve anytime in the near future. There will be a small boost to employment during the holiday season but the reality is that unemployment is still bouncing between 9.6 and 9.7 percent and jobs aren’t being created fast enough to being affecting this number in a significant manner.

That’s nothing new but for those watching the commercial real estate market, its important to understand that the last 3 years have produced a change in the ways that companies utilize office space. Office space is of course one of the largest expenses for any company and now businesses are placing a higher priority on efficiency than ever before.

Some examples include smaller furniture, compact floor layouts, more overhead and wall storage to reduce floor use. Hiring a good office planner is now a requirement for medium to large spaces. In addition to more compact space, businesses that are hiring are generally filling existing space that was vacated by former employees. The bottom line is that efficiency and existing accommodations mean fewer square feet of space are being absorbed.

Another factor to consider is that companies are investing their resources into projects meant to optimize their bottom line and that the longer our economy remains stagnant, the pressure to improve efficiency will increase. A department that required 2,000 employees before the recession could now produce the same level of output with just 1,600 employees. Many companies have combined smaller square foot requirements with more efficient production methods to significantly lower their office expenses.

In some markets this shift will compound the office market recovery even with increased hiring. The bottom line is that demand will continue to slack in the foreseeable future.

Commercial Real Estate Begins Recovery?

In 2008 and early 2009, market observers warned that the next crisis would be the commercial real estate sector and the commercial market has indeed been through a rough period but new data suggests that a recovery may be occurring in some sectors of the market.

Of course let’s not forget that we aren’t out of the woods yet when it comes to the commercial market. The current national vacancy rate stands at 17.5 percent and more than $1 trillion in commercial debt is coming due within the next 4 years as landlords struggle with weakened demand, lower rents, a stagnant economy and decreased property values. Not to mention the current delinquency rate for CMBS topped 9 percent.

The bad news gets worse as many companies already leasing space have empty desks and cubicles meaning that hiring new workers won’t require new space and new layouts / floorplans have reduced the amount of square feet allocated to each employee. Its the early 1990s all over again but this time vacancy rates are the result of weak demand instead of too much supply.

So after all of that, some markets are seeing a stabilization and in some cases improvement in commercial leasing.

New York has seen rents increase thus year by 0.2% while Washington DC has maintained a vacancy rate below 10 percent. Average effective rents (which include concessions like free or phased-in rent) nationwide fell $0.01 in Q3, the smallest decline for any quarter since 2008. The nationwide vacancy rate, while high at 17.5 percent, is now predicted to crest before the 18.7 percent which was reached in 1992.

But like I mentioned earlier, the previous commercial real estate crisis was a supply problem, this crisis is a demand problem. The commercial market is tied to the jobs market ie more jobs = more space required. Its a simple equation which is hard to fulfill as the economic recovery remains stagnant and open floor plans are reducing the amount of space required by tenants.

Are we about to see drastic improvements in the commercial market in Q4?
The answer is no.

Are we going to see the market get worse?
Certainly this will be true for metropolitan areas hit hard by the recession but less affected areas the office market is likely to improve.

Should businesses lease now before things start to improve?
Companies will continue to have a lot of leverage throughout 2011 but in areas like Manhattan and DC this would be a good time to start looking at leasing space in order to lock in the better deals.

Is Orange County office market stabilizing?

Vacancy rates for Orange county remain high but the market has begun to stabilize as landlords have become more aggressive in terms of asking rent and concessions to lure clients.

Orange County’s office space vacancy rate is still above 18 percent but the rate inched down a fifth of a percentage point to 18.2 percent in Q2. The drop is seen as the result of an improving job climate and landlords offering more concessions and perks to attract tenants to vacant space. Orange County still has the lowest unemployment rate in Southern California at just over 9 percent compared to 12.4 percent statewide.

TARP Watchdog Concerned over Commercial Loans

Elizabeth Warren, chairman of the Congressional Oversight Panel of the Troubled Asset Relief Program, warned that regulators should prepare for possible negative consequences from commercial loans.

The report claims that between 2010 and 2014, loans worth $1.4 trillion will reach the end of their terms and almost 50 percent of those loans are underwater. When a loan is underwater it means that the borrower owes more than the property is worth and that if they are unable to get the loan refinanced, they could create serious problems for the banking industry.

The report claims that small and mid-sized banks could be hit the hardest and that hundreds of them may fail due to the fact that more 3,000 banks have stakes in commercial loans and more than 2,000 of them have total assets between $100 million and $1 billion in total assets.

There may not be a silver bullet to stop the problem and regulators are currently evaluating their options. Some of those include capital injections, federal loan guarantees or lending assistance to small businesses.