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Business Observer Monday, Aug. 25, 2008 12 years ago

Sharp Correction

The once hot market for commercial real estate in the Fort Myers and Naples area has cooled. Tenants can take advantage of the situation to renegotiate lower rents.
by: Jean Gruss Contributing Writer

These days, it seems only the government is growing.

Randal Mercer, a Fort Myers commercial office broker, had a meeting with the Internal Revenue Service early one recent morning, but he didn't expect 17 employees to show up to tour the new office space he was about to show them.

“I paid my taxes,” Mercer pleaded with the small crowd. “We know,” they replied nearly in unison. “We checked.”

You can't get a more secure tenant than the IRS. “For sure they'll pay rent,” Mercer says. “They may be the only ones left on the planet,” he jokes.

Or at least that's the way it seems today as private-sector tenants struggle to pay the rent on offices, warehouses and stores. “We're seeing our base rents drop 20% to 25%,” Mercer says of office space in Fort Myers and Naples.

Rents are declining because vacancies are rising and landlords know they'll have a tough time replacing any tenant who vacates space. “The big question mark is whether it's a long-term thing or not,” says Todd Holman, an industrial-space agent at Woodyard & Associates.

Holman is firmly in the camp that a full recovery is several years away. “It's unrealistic to think that Mickey will come down here and open a 600-acre fun park for Goofy,” he jokes.

Job losses are at the heart of much of the pain and could prolong the downturn. “Clearly the unemployment rate is going to increase, which is going to drive vacancies up and rents down,” says Gary Tasman, a broker with Cushman & Wakefield in Fort Myers. “Companies lay people off all the way into the downturn and don't start hiring again until after the initial uplift.”

Already, Lee County was one of the first counties in Florida to report a double-digit unemployment rate of 10% in December. “I don't think the economy will turn around until sometime next year,” Tasman says. “This is the great
rental market correction.”

The holidays didn't boost anyone's spirits, says Karen Johnson-Crowther, principal and director of retail services with Colliers Arnold in Fort Myers. “I suspect we're going to see more store closings after Easter,” she says.

Office space is emptying
Because the Fort Myers and Naples areas are considered tertiary markets, national and regional companies are shutting offices and consolidating operations in places such as Tampa, Orlando and Miami.

With the real estate downturn, architects, engineers, law firms and associated professional services are downsizing as well. To keep them from moving to cheaper space, many landlords are cutting rents so their tenants can make it through the downturn.

Mercer cites the recent example of a title company that used to pay $5,200 a month and now pays $850 a month because the landlord doesn't want to lose them as a tenant. “If they move, you won't be able to fill it up for a while,”
Mercer says. “It's better to have $850 than $0.”

No one seems to be immune. Physicians have told Mercer that their patients are behind on making payments and insurance companies are slow to provide reimbursements.

Job losses have been the drag on office rents, wiping out any gains made during the boom years. According to data compiled by CoStar Group, Charlotte, Collier and Lee counties have reported a cumulative loss of '‘4.2% of office
jobs over the past five years while office space has grown by 14.6% in that same period. That means that if the market was in equilibrium then, there's an 18.8% oversupply of office space.

“We could see a 20% vacancy rate in Lee County over the next two years,” says Tasman. Rents that are now quoted in the teens may sink to single-digits in that time frame, he adds.

As a result, landlords who purchased buildings at the height of the boom are likely to begin defaulting. “The trend for foreclosures of commercial real estate is going to be up significantly,” Tasman says. This year, he expects 50% of his work will be with banks, up from less than 2% in previous years.

Building trades empty warehouses
Last year, Lee County issued 79% fewer permits for single-family homes than in 2007. That's hurt the building trades, which filled much of the industrial and warehouse market in the Fort Myers and Naples areas. “They're downsizing still,” says Holman.

Areas such as the Alico Road industrial corridor in South Lee County have been hit particularly hard because a lot of buildings were built in recent years. “A lot of national or regional [companies] don't have enough sales to keep their points of business open in the county,” Holman says.

As a result, asking prices for buildings are starting to come down from $100 a square foot a year ago to the $60 range. “You're going to see who is motivated and who isn't,” Holman says.

Holman estimates there's enough empty industrial space to last for many years, a situation aggravated by the Lee County Commission's increase in new-construction taxes early in 2007 that artificially spurred construction. “What I say to people is I can only see out about four or five years. That's as far as I can see and I think we have inventory for that period of time,” he says.

To fill that space, residential construction will have to rebound, something that's not likely to happen as long as there continues to be a glut of housing.

Hope for good tourist season
If the traditional tourism and winter-resident season is bad for retailers, it's likely more stores will close after Easter when part-time residents head north. Already, the area's high unemployment rate and low consumer confidence is hurting stores.

“I don't think we're done, unfortunately,” says Johnson-Crowther. “This is the busy season. Will they be able to hang on when the tourists leave?”
Vacancies are likely to continue to rise and rents will keep falling. Rents for shopping centers that were quoted in the high $20 range have fallen into the teens. “We are back to levels 10 years ago for new properties,” says Johnson-Crowther.

Landlords are starting to offer free rent to tenants just to keep their centers full, some brokers report. However, Johnson-Crowther says only good tenants are getting rent-relief. “You have to make sure tenants are not crying foul,” she counsels landlords. One way to do that is to examine the tenant's tax receipts for the last two years.

Discount stores and auto-parts stores are doing the best in this market because people are looking for bargains and are more likely to fix their cars than buy new ones. Apparel and electronics are performing the worst. “Luxury goods were maintaining their level until recently,” she says.

Land is getting dirt-cheap
Land prices are falling more rapidly than commercial buildings, in part because land generally doesn't produce income.

“Vacant, approved residential land is down to 10 to 15 cents on the dollar at peak 2006,” says Tasman.

“Commercial land could see a 75% correction and we're just beginning to see it now,” Tasman adds. “We're doing valuations now and we're seeing 50% corrections.”

The bottom of commercial-land prices is years away. “We could be five years out,” Tasman says. Up to 70% of the financed land will revert back to bank ownership, he predicts.

For commercial land to rebound, commercial activity needs to pick up, vacancies need to decline and rents have to rebound. “Vacant land is really taking it on the chin,” Tasman says. “It's the most severe correction of any product type that I track.”

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