Commercial real estate is heading into its worst year since the industry's crash of 1991-92 and likely won't see a significant rebound until 2011 at the earliest, according to industry experts.
Commercial real estate is heading into its worst year since the industry's crash of 1991-92 and likely won't see a significant rebound until 2011 at the earliest, according to industry experts.
Many predict that property values will tumble 15% to 20% on average from their 2007 peaks, with even steeper declines coming in weaker markets.
"It's not going to be pretty next year," said Sam Lieber, chief executive of Alpine Woods Capital Investors LLC in Purchase, N.Y. "Commercial real estate is going to be under pressure for the next two years" from declining demand, falling rents, rising vacancies and liquidity issues, he said.
With so much uncertainty surrounding the length and depth of the recession, the frozen credit markets and the effectiveness of government bailout programs, experts are having a rough time forecasting a bottom.
"This is the third recession that I've been through with Grubb & Ellis [Co.], and I think there are more question marks at the end of this one than any of the previous two as to how we're going to get out of it and how deep it will be," said Robert Bach, chief economist with the Santa Ana, Calif.-based commercial-real-estate-services and investment company.
At best, the country may see modest economic growth in the second half of 2009, he said.
Since commercial real estate tends to lag the economy, it likely won't bottom until mid-2010 at the earliest — "and that's if we're lucky," Mr. Bach said.
"This is going to be the worst year since the 1991-92 industry depression," said Stephen Blank, senior resident fellow for real estate finance at the Urban Land Institute in Washington. "It's a bleak picture."
Fitch Ratings Ltd. of New York recently downgraded its 2009 outlook for equity real estate investment trusts to negative, from stable.
Mr. Lieber is predicting that unemployment will reach 8.5% to 9% by yearend, which does not bode well for real estate demand. Meanwhile, property values will fall 10% to 25% over the next 18 months depending on the location and property sector, he said.
Medical-office properties, apartments and industrial real estate are expected to weather the recession far better than office buildings, malls and hotel properties, according to Mr. Bach.
Publicly traded real estate companies and REITs have already taken a beating in anticipation of the meltdown, losing about half of their value in 2008. "In some cases, values have already fallen as much or more than [the housing market]," said David Jacobstein, senior adviser to Deloitte & Touche USA LLP's real estate practice in New York. "They're ridiculously low, and dividend yields are at historic highs." Still, some names may have further to fall.
The biggest challenge facing real estate in 2009 is credit.
Indeed, investors have cast a nervous eye toward REITs that have a big chunk of their debt rolling over in the next year or two. Many worry they'll be unable to refinance the debt in the frozen markets, which could threaten their future.
The debt wake-up call came in early 2008 when stunned investors watched New York mogul Harry Macklowe sell off some of his crown jewel properties, including his prized General Motors Building, to meet debt calls.
The chairman and chief executive of Macklowe Properties Inc. of New York had gone on a buying spree at the height of the real estate boom in 2007, purchasing seven skyscrapers in Manhattan for about $7 billion.
When the music stopped in the credit markets, Mr. Macklowe was unable to refinance his debt, forcing him to sell off properties to keep creditors at bay.
Credit concerns escalated later in the year when a couple of blue-chip names in the REIT world — General Growth Properties Inc. in Chicago and ProLogis in Denver — frantically struggled with debt problems. In a Nov. 10 filing with the Securities and Exchange Commission, General Growth ominously warned: "Our potential inability to address our 2008 or 2009 debt maturities in a satisfactory fashion raises substantial doubts as to our ability to continue as a going concern."
All of this caused spooked investors to dump REITs this past fall, with many nervously speculating on who might stumble next. REITs facing the biggest risk are those whose debt levels exceed 70% of total market cap and those with a significant amount of debt, especially unsecured debt, rolling over in 2009 and 2010.
However, the credit crisis could present a buying opportunity for investors and REITs with the means. A mountain of debt created during the frothy real estate boom of 2006 and 2007 will start rolling over in 2009, 2010 and 2011, said Glen Esnard, president of the capital markets group at Grubb & Ellis. "A lot of that debt is not refinanceable" in the current markets and could be sold at fire sale prices.
Last October, even billionaire investor Carl Icahn pontificated, "On an internal-rate-of-return basis, you're getting 15% or 16% for debt that should have hardly any risk."
"Distressed debt is where it's at," said Mr. Jacobstein. "There is an awful lot of people with a lot of money sitting on the sidelines waiting" to jump in, he said.
E-mail Janet Morrissey at jmorrissey@investmentnews.com.
