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Business Observer Friday, Jan. 23, 2009 12 years ago

Choppy Waters

Strong headwinds from multiple fronts assail commercial real estate, but glimmers of hope peer over the horizon.

With fewer new rooftops to follow these days, commercial development faces a stiff headwind of rising vacancies, foreclosures, and unemployment, plus credit crunch challenges from previously reliable lending sources.

But some say opportunities are presenting themselves, albeit mostly for those with good credit or plenty of cash.

Contributing to the choppiness are banks like J.P. Morgan Chase & Co., purchaser of most of Washington Mutual's operations, and Wells Fargo, who swooped in to grab Wachovia. Unless they choose to advertise with block and stucco, sooner or later these consolidations can be expected to add to the rising office and retail market because they will close branches next to each other. That will further depress prices.

Commercial sales prices are well off their highs now, perhaps no more so than in Southwest Florida. “Sales that are happening are at dramatically reduced prices,” says Paul Sands, Partner and Senior Advisor with VIP Commercial in Ft. Myers. “By that, I mean (compared to) a year ago. Take industrial — we were getting $125 a foot for a nice deal in our market, for example, Metro Parkway. Today we are getting $80 a foot.”

In contrast, the average sales price in the Tampa Bay industrial market is only 10% off the highs according to John Dunphy, managing director and principal, Industrial Services, with Collier Arnold in Clearwater. “Sales are off 50-70% on the volume side. For the most part, the vertical construction projects are being put on hold. Interestingly enough, though, we haven't seen a drastic reduction in the purchase prices. In Pinellas, the average is within 10% of what we saw last year.”

He says that vacancy is up about two percentage points and the expected trend line is that values will continue to fall.

Landlords get the message
Data from Costar for the Southwest Florida industrial market shows vacancies have risen to 10.2% in the third quarter from 9.4% at the end of the second quarter 2008. The chief culprit: a dramatic rise in the flex space vacancy rate to 27.4%, up from 21% at the end of 2007.

Vacant sublease space is up to 155,000 square feet from 29,600 at the end of 2007. The loss of 4,800 construction jobs in Lee County since September 2007, representing almost 16% of the county workforce, would explain the vacancies. “All the guys that aren't there anymore”, says Sands, “were companies that supported the construction industry.”

Evidence of the loss of construction employment is also reflected in the Sarasota/Bradenton submarket where 3,000 — or 12.4% — of construction jobs have been lost from September 2007 to September 2008. Year-to-date net absorption of office space is a negative 553,000 square feet, the largest of any submarket in the Tampa Bay market, where total net absorption exceeds negative 1.3 million square feet.

Not helping matters are banks' commercial foreclosures.

“They are now just getting the message,” says Sands, “they don't want the word on the street. I meet with a lot of asset managers. They have a lot of foreclosed assets. When I meet with them about these assets it's not a very pleasant meeting.”

When asked if the unpleasantness was because of having to tell them the assets are not worth as much as they would like, his quick response was, “You better believe it.”

Also, landlords are “finally getting the message,” Sands' says, as they are upside down with few or no leasing prospects. “I don't think they were planning on having their buildings vacant for as long. It's better to have some cash flow and get tenants in the building and see where it goes in two or three years.”

Of course, all this new supply presents opportunities for those wanting to upgrade their space. “I just did a deal with a pretty high-end industrial client at $7 per square-foot for second generation space, but had 25-foot ceilings, well located, but were able to get it at a very reasonable price and a very long term deal,” says Sands.

As stressed consumers cut back and retail sales decline, retail market vacancies rose to 5.6% in the third quarter of 2008 from 5.2% in the second quarter. Quoted rental rates have declined over the last quarter as new construction deliveries exceeded three million square feet over the last four quarters, well above the annual average over the last four years of 1.4 million square feet.

In Sands' words, “retail pricing has taken a dramatic hit.” A lot of these guys have not gotten the message that they are going to sit with vacant space. They have to make below market deals for a time. We have a property management division and they are turning in the keys. I call that real time front line feedback. There are 74 vacant restaurants in (Lee and Collier) right now plus another 10 or 12 in Charlotte.”

That does not bode well for future vacancy rates and could put further pressure on prices. Rising unemployment, which climbed from 5.7% a year ago in Lee County to 9.2% in September, will only add to the difficulties in navigating the commercial real estate market in Southwest Florida.

Collier County's unemployment rate actually dropped in September, if only slightly, to 8.4% from 8.5% in August. Charlotte County's rate rose to 9.5%, up from 6.3% in September 2007. For Florida, the jobless rate was up to 6.6% representing no change from August, but significantly higher from a year ago when it stood at 4.2%.

Credit crunch clouds
The daily changing uncertainty of bank credit is another big storm cloud over an already drifting Gulf Coast economy. Although more recent news in the credit markets has been positive, “Lenders are reviewing every loan, credit lines are being decreased or taken away,” says Sands.

Bob Bassett, Colonial Bank Area President and Senior Lender for Lee and Collier Counties confirms Sands' assessment to a degree. “If we got a good opportunity, we make a loan. We're not looking at speculative opportunities. We're looking at investment type income.”

He says the leases that support solid investment income are with good quality companies where the income stream is there over time support the building.

Dunphy at Colliers Arnold puts it differently. “What they're going to tell you is we're lending money, but only the cream of the crop are going to get those loans.”

The decrease in commercial lending volume has changed Bassett's bank. “For us the dollar volume relative to the previous quarter is about the same, but behind the third quarter of 2007,” he says. He attributes most of the lower volume to the softer commercial market, not tighter lending standards.

In Pinellas County there have only been 25 commercial and industrial sales of 10,000 square feet or more so far this year. Last year there were 61 sales.

Speaking in mid-October, Dunphy says the lower volume is “due to credit certainly, but a large portion is due to the general slow down in the economy. It's not as bad as RTC (Resolution Trust Corporation) days. Credit is much more stringent than it was. People are looking for good solid deals. If I wait, am I going to get the same deal with a better yield?”

Brian Rothschild, managing director of corporate solutions for Colliers International, offered a less optimistic perspective from his Manhattan office in early October as the credit crisis was in full swing.

“I am being told by a Fortune 50 company that they have buildings to sell worldwide that nobody can sell, because no one can get the credit. Banks are holding on to their money. They don't have it so they can't lend it. There's just nothing going on. It's very, very limited. As far as Florida goes, there's no question that credit is extremely limited.”

Sunbeams or storm clouds?
If there's a sunnier side in commercial real estate it's the lower prices, though businesses are taking their time to relocate, waiting for leases to expire.

According to Sands, if a company has been operating a B or B+ space, it can move into A space for the same money when the lease expires. “Landlords are glad to have them, but we are not recommending long term deals so we can talk about it when this storm passes,” he says.

Colonial's Bassett agrees. “Class A office space vacancy and the negative absorption creates opportunities,” he says. “It's a buyer's market. While painful for some, it can be beneficial for others.”

Also salivating over lower prices are some vulture funds and Real Estate Investment Trusts (REITs). Bassett says the people who are buying are the ones who think we are at the bottom of the market. “A lot of cash is on the periphery. There's been some good size transactions.”

Dunphy confirms that assessment: “There are vulture funds that are extremely well capitalized. They're out there.”

He also agrees with Sands that there is a disconnect between buyer price and seller price that needs to work itself out for the market to move forward. At the same time, Dunphy points out that some projects in south Hillsborough
County that have been sitting around for awhile are getting more aggressive deals today than they would have a year ago.

In addition to banks selling branches and other REO properties, Sands thinks Merrill Lynch, purchased recently by Bank of America, might enter the fray. “I can see where Merrill Lynch might be taking a look at their real estate portfolio.”

The optimistic banker, Bassett offers some hope.

“The commercial properties are holding up better than the residential. It will be soft, but I don't think it will be as deep or as long. The key is that it isn't going to last forever.”
Other reasons to be somewhat more optimistic surfaced recently. Home sales in Southern California rose 65% in September from a year ago although it took a 34% price decline from September 2007 to get buyers back in the market.

Plus, the average 30-year mortgage rate on an owner-occupied single-family home with 20% down dropped to 6.125% from 6.5%. Lower rates and prices could help the existing housing inventory to be absorbed more quickly.

Perhaps it was Dunphy who summed it up best, saying, “It all comes down to job creation. When job creation comes back you'll see this whole thing turn around.” He also says it would help to get rid of the impact fees and get cheap money out there.

With rates for the much watched three-month London interbank offered rate, or Libor, trending back down, it appears that credit markets are stabilizing, even as a recession soon becomes official. The Wall Street Journal still cautions “it could be weeks or months before the (credit) markets return to normal.”

Nonetheless, if the stormy seas don't calm down as soon as buyers and sellers would like, the industry can follow the lead of CB Richard Ellis commercial real estate agent Al Molin in the Fort Myers-Naples office. For any agent who brings Molin a buyer for two former Bob Evans restaurant buildings, he will throw in a year's use of a brand-new 2009 Mercedes, insurance included.
Now that may be enough for many to get off the choppy seas and back on solid ground for a smoother ride.

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