The question is how does this affect the commercial real estate market? Commercial real estate activity is down 75% year over year as of the end of the 3rd Quarter of 2008. The number is slightly misleading, because prior to 2008 the amount of real estate transactions was inflated. The overall real estate market had heated up to the point where commercial real estate was being traded instead of invested.
As we are aware real estate asset values are depreciating. The extent of which remains to be seen. As a nation, we risk a negative asset bubble. The reason for this is that the short term financing on many commercial real estate projects start coming due in 2009, and most will reset through 2012. With the credit markets locked up we face the potential of systematic maturity defaults in the commercial real estate market. There is a lot of money sitting on the sidelines waiting for just that occurrence.
Another reason these loans will face trouble refinancing is because as the economy gets worse there is a widening gap between the pro-forma predictions on which these mortgages were underwritten and the actual performance of the property. Occupancy upon completion of commercial real estate projects has dropped from 85% at the peak of the market to 62% as of the end of the 3rd quarter 2008.
Looking at specific asset classes, the positive is office and industrial properties were not overbuilt during this last boom, so although vacancies will rise based on the economy; the vacancies are manageable and projects that are complete can continue to cash flow, on slim to little margins, but well managed projects in these sectors will service their debt. Project developers and owners, however, can expect strong competition for tenants. As per a large lending institution that focuses on commercial real estate, they are seeing rent decreases as much as 20% in some markets.
As an asset class, retail properties will struggle through 2009 into 2010. Vacancy rates are climbing steeply and the vacancy trends are structural. Retail is more closely linked to residential than are office and industrial. Big box developments in overbuilt residential neighborhoods are especially susceptible to vacancies. There are structural factors that adversely impact retail. Consumer access to home equity loans is greatly restricted, which restricts consumer spending. Retailers are over inventoried, however, the impact of inventories will clear up by the end of the 1st quarter 2009.
The outlook for multi family varies greatly by market throughout the U.S. In markets that had many condo and conversion projects, vacancy rates are increasing. That's because many of the condo and condo conversion projects are reverting to apartment use and causing an overbuilt scenario. In markets that did not have many condo and condo conversion projects vacancy rates are low, and rents are increasing. As a rule of thumb, most Tier 2 markets are good for multi family real estate.
For office, industrial, and retail properties; the current real estate market creates good buying opportunities for well financed, well informed investors, that are not dependant on debt financing.
In the right markets, multi-family is a good investment. In those markets, properties are maintaining their value, and rents are increasing. Also, this is the one asset class that still has a secondary mortgage market. Fannie Mae and Freddie Mac are buying multi-family mortgages, albeit the equity requirements have increased; but multi-family purchases can still be debt financed.
In summary; for office, industrial, and retail look for buying opportunities starting in early 2009. Debt financing is scarce for these projects, which creates strong opportunities for cash buyers. Expect more seller financing and syndications to fill the financing void.
For multi-family, study the market. There is good value in this environment in markets that are not over inventoried. Buyers that have strong credit, and can afford equity payments of 25% to 30% have an advantage.
Over the next 18 months there will be many "good buys." This is a market for sophisticated investors, study the project, study the market (growth, demographics, underlying local economies), know the tenants, and study the leases. There are some excellent buys, and fortunes are made in these markets; but this is a sophisticated investor's market. If you are new to real estate, you can still get in, but find a good, knowledgeable professional to guide you. A reasonable investment in professional guidance can lead to large future returns.
