eirmoney | Commercial Property - Spotlight on the U.S.

Commercial Property - Spotlight on the U.S.

Posted by Emil Okanovic | 16 September 2009

U.S. commercial property market remains mired in recession, not yet the recommended investment choice

The economic recession and the severe credit crunch have weighed heavily on the commercial real estate market in the United States. Sales volumes, construction, and prices collapsed, along with sharp increases in vacancy rates and negative net absorption. The short-term prospects do not look promising, given expectations of continued job losses and extended liquidity constraints.

Severe credit crunch, which some experts from the U.S. National Association of Realtors have called the worst in a lifetime, have slashed sales of commercial real estate properties in the United States. In its latest survey of senior lending officers, Federal Reserves stated that banks have seen a steep decline in demand for commercial real estate loans, suggesting demand for commercial properties remains subdued. In fact, Fed survey said in the first quarter the highest net percentage of banks reported a drop since the Federal Reserves began tracking demand for these loans back in April 1995. Constrained liquidity will keep demand for commercial properties suppressed in the near future, making possibilities for reasonable property value appreciation highly unlikely.

At the same time, according to research from Real Capital Analytics, the severe credit problems have caused the number of distressed properties in the market to rise substantially. Currently, there are about 2,300 distressed commercial properties in the United States, which amounts to some $50 billion. Out of this, over a tenth is in foreclosure or bankruptcy. This also suggests that the abundance of distressed assets in the market will continue to exert a downward pressure on property prices in general. However, there still may be good investment opportunities in select distressed properties in the areas that have a high future employment potential and that boast a good demographic profile.

Still, looking specifically at different classes of commercial real estate, job losses have exerted an especially strong pressure on office space. Office vacancies in the United States have increased to a multi-year high of 15.5% in the first quarter of 2009. The prime culprit behind the increase in the vacancy rate is the extended weakness in the labor market. Given the negative absorption of new construction and plenty of vacant existing space, extended weakness in the job market will likely take away the hopes of a sustained recovery in the office market before the second half of 2010.

The same bodes for the U.S. retail property market. Retail real estate has already suffered a blow from weak consumer spending, due to mounting job losses and the bursting of the U.S. housing bubble. As a result, vacancy rates for retail properties are expected to climb from the last year’s rate of 8.9% to 10.5% this year. Investment flows and total returns on retail properties have already dropped substantially. For instance, the Moody’s/REAL total return index for retail real estate shows a steep drop in total returns in the first quarter, which has taken the index value back to the 2004 levels. Weak U.S. personal spending prospects will make retail real properties less attractive than earlier, although it should not be excluded that specific discounted properties in prime areas could make good long-term investment choice.

The industrial property market in the United States has also had its share of troubles in this recession. Manufacturing, especially in the auto industry, has hit the market hard. As a result, industrial vacancy rate in the United States increased by a full percentage point from the last quarter of 2008 to 11.5% in the first quarter of 2009. Rental rates have also been declining. Still, the early signs of recovery in manufacturing worldwide suggest that the market could turn around by mid 2010. Nevertheless, the recovery will not be robust and the yield on investment in these properties is unlikely to be anywhere as high as it was prior to the economic recession.

Finally, multifamily housing, which is usually the commercial property type most resilient in the economic recessions, has been bruised by substantial employment losses, especially among the new labor market entrants who are typically the prime renters. In the latest quarter, national apartment vacancy rates have climbed to the highest in two decades and rents have been slashed to retain occupancy. Still, some rental markets, in particular that of New York City, have been able to buck this generally weak trend. Given poor prospects for the imminent recovery in the job market and weak prospects for large immigration growth in the future, the U.S. apartment market is unlikely to stage a robust recovery anytime soon. Again, while the market as a whole may be stuck in a downturn for a while, particular investment opportunities should not be ruled out in certain areas that feature a positive long-term demand prospects.

Overall, even though commercial real estate in the United States remains mired in the severe downturn—in sync with most commercial property markets in the world—opportunities for making good investments in the current environment could exist. Many attractive investment opportunities may exactly be located among distressed commercial properties, whose values have been decimated, yet whose long-term potential has remained intact.