The Real State of Commercial Real Estate
In our fifth annual top executive interview, Ross Moore, executive vice president at Colliers International, answers some tough questions about one of the nation’s hardest-hit markets: commercial real estate.
To state an obvious fact, the very foundation of the North American commercial real estate industry is cracked. Overdue lease payments, credit shortages, and vacant storefronts are just some of the problems facing the downtrodden market. While the situation may worsen before it improves, Ross Moore of Colliers International provides hope of an upswing, possibly as early as 2010.
BF: How would you describe the current condition of North America’s commercial real estate market?
Moore: Although starting from a position of relative strength, most commercial real estate markets now are experiencing extremely weak leasing conditions characterized by rising vacancy levels and a softening in rents. Even businesses that to date have not been adversely affected by the economic downturn are expressing a reluctance to commit to new or additional premises. With working capital in short supply, firms that have leases expiring are choosing to renew rather than take on the expense of moving and associated costs. Many of these renewals are short term, highlighting the highly uncertain environment in which most companies find themselves. On the landlord or ownership side, with the debt markets highly constricted, financing is very difficult to source, which leads to real difficulties for many who must refinance anytime this year and possibly next. Real estate values across almost all regions and all property types are, as a result, falling at a rapid rate.
BF: What regions are experiencing the most difficulties? Can you identify any regions that are prospering during the real estate downturn?
Moore: Every region of the country now is experiencing difficulties, but to different degrees and for different reasons. The Sunbelt states of Florida, Arizona, Nevada and California are where weakness is most widespread. A housing depression characterizes these states, but sluggish business conditions now are evident across all sectors of the economy. Rents in these states are falling and demand for all types of space is well below trend.
The second depressed region is the Rustbelt states with Michigan being the epicenter, but extending through much of the Midwest. The auto sector is a key source of weakness for much of this region, but almost all economies with a heavy manufacturing bias are facing very challenging business conditions.
The third region is New York/New Jersey, with its high concentration of financial services jobs. Layoffs among many of the investment banks remain elevated and businesses of all types are scaling back where possible.
Texas, and Portland and Seattle in the Northwest, are two regions which only began to slow recently and are expected to outperform the country measured against most metrics.
BF: How have the closures of many retail super-stores affected their communities? Do you foresee these commercial properties being repurposed or remaining vacant?
Moore: Empty stores are never a good thing. Vacant stores don’t help neighboring retailers and become a target for vandalism and usually fall into some form of disrepair.
Leasing up large stores is never easy, and never more difficult than in the current environment. Many will have to be retrofitted for alternative use, while some may sit empty until the economy recovers. In a worst-case scenario the building will be demolished and the site redeveloped. In every up-cycle a small percentage of retail space gets developed where it probably shouldn’t. This cycle was no different.
BF: How has the emergence of sustainable development changed the face of commercial development?
Moore: Sustainable development is here, period. Whether office, retail, industrial, multi-family, hospitality or mixed use, all forms of real estate development are adhering to some level of sustainable or green building criteria. Municipalities are insisting on it, lenders and investors want it and, most importantly, tenants are increasingly showing a strong preference for premises that meet some form of LEED standard.
BF: What effect do you think the federal government’s economic stimulus package will have on the commercial real estate sector?
Moore: In the short term, none. Late in 2009 and then increasingly in 2010, select office and industrial markets will feel the benefit. Washington, DC in particular will get a substantial boost with many governmental agencies having an immediate need for additional office space. Beyond Washington, very few office markets will see a significant pick-up in demand. The effects of the stimulus package will be more widespread for industrial, with those that are home to anything connected to infrastructure being the primary beneficiaries.
BF: How can companies keep their real estate developments in production during these difficult times? For projects that haven’t yet broken ground and have been postponed, are there any moves that can help keep the deals intact?
Moore: Capital is very scarce even for existing properties, never mind new development and the associated risks. Lenders are very reluctant to lend even to credit-worthy borrowers with whom they have an established relationship. For projects that haven’t broken ground, pre-leasing and lots of equity are required.
BF: How are developers dealing with the current credit crunch?
Moore: Developers are cutting expenses, shelving developments where possible and selling assets that are not viewed as core. Many have gone into survival mode working with all stakeholders to maintain cash flows and preserve capital. For those with debt maturing anytime soon, most can expect a call for more equity, as loan-to-value values have dropped substantially to 50% to 60% and appraisal values may have fallen by 30% to 40% since originally financed. Private equity funds are one possible option but, to date, most are still waiting for signs that values have bottomed.
BF: Do you expect to see consolidations of major real estate services? If consolidations do occur, what steps are Colliers taking to ensure it remains a leading industry force?
Moore: In every downturn there is consolidation; this will be no different. Every real estate service provider has seen a significant drop off in revenues but those only involved with sales and not leasing have seen the biggest decline. With deep roots in almost every market we operate and a diverse range of services, Colliers is extremely well positioned to survive a difficult downturn and is actively recruiting new real estate professionals.
BF: How long do you think it will take for commercial real estate to see a significant upswing?
Moore: Office tenants, industrial users and retailers are all expected to return millions of square feet to the market throughout 2009 and possibly into 2010. With continued job loss, the drop in industrial production and the sluggish retail environment, most businesses are looking to reduce real estate costs. With the economy not expected to show growth until late 2009 at the earliest and sustained job growth unlikely before the first quarter of 2010, real estate will not experience a significant upswing until mid to late 2010 at the earliest. The good news is supply never got out of hand, but the pain for real estate owners and investors will be substantial. Recovery will come but the damage will have been significant.
As Colliers International’s executive vice president and director of market and economic research, Ross Moore is responsible for strategic planning, new product development, and market and economic analysis. Moore holds a B.A. in economics, has previously worked in the UK for a global real estate service provider, and is a recognized industry expert.
Topic Tags: NJ