It’s all about liquidity, and there just isn’t enough of it to go around to save the U.S. commercial real estate market. At least, that’s the sentiment of a growing number of economists who say the next big boot to drop on the economy will come from commercial real estate.
The genesis of the commercial real estate problem looks a lot like the housing market — overly-liberal lending. More or less, anyone who wanted to buy a strip mall, apartment complex or an office building could get one — banks hung a big, honking green-light outside their door and plenty of otherwise ill-financed investors took full advantage.
But now the bill is coming due. According to a PriceWaterhouseCoopers’ report called “Emerging Trends in Real Estate 2010,” commercial real estate property values are the worst since the Great Depression, falling off by 50% across the U.S., the report says.
Few are expecting the market to get healthy soon. The report also says that, in 2010, “A lackluster economic recovery characterized by problematic job growth will hamper the pace of any real estate market resurgence."
Why the sharp decline in commercial real estate values? Here are a few key reasons:
Vacancy rates — Office buildings and apartment complexes just aren’t filling up. The PriceWaterhouseCoopers report says that national vacancy rates will be up to 19% by the end of 2010. That’s the highest rate of vacancies in 24 years. It’s not rocket science — more vacancies means less money for real estate owners to pay back loans. And that could lead to rampant foreclosures.
Scarcity of buyers — Even with commercial real estate property values falling by 40%-50%, potential buyers don’t believe the market has hit bottom yet. So they’re staying on the sidelines until they believe the market does hit bottom. Hey, why buy a distressed property at $300,000 when you believe it will fall to $250,000? Many commercial real estate market projections for 2010 say the market should drop by another 10%-20% in 2010.
Lower rents — What better time than in the teeth of a massive recession to negotiate lower rents? With vacancies up, and landlords desperate for cash, renters have owners over a barrel — they can ask for significantly lower rent and lease deals. But when landlords take less money, that threatens their ability to pay their loans, and further greases the skids for a declining real estate market.
Consumers are cutting spending — Office buildings are closing right and left as businesses go under. Why? With consumers spending less money, businesses are hurting, and many of them are shutting down. According to the real estate research firm Reis Inc., office rents fell by 8.5% in the third quarter of 2009 — that’s the steepest decline in 15 years, the firm reports.
Economists call the commercial real estate market as the "second shoe to drop." If it does, it will take that much longer for the economic malaise to snap back to good health.
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