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Monday, November 10, 2008

Commercial-real-estate bust is coming, report warns

But downturn will present buying opportunities over the next 18 months, industry expert says

InvestmentNews

By Janet Morrissey October 26, 2008, 6:01 AM EST

Economists and market experts say a doom-and-gloom report on commercial real estate released last week confirms the industry's worst fears about an imminent major correction.

The widely respected annual report, "Emerging Trends in Real Estate," by the Urban Land Institute of Washington and PricewaterhouseCoopers LLP of New York, predicts that in 2009, commercial real estate will suffer its worst year since the industry's crash of 1991-92, with a noticeable rebound unlikely until 2011 at the earliest. It also forecasts a decline of 15% to 20% in property values, on average, from their 2007 peaks, with even sharper declines coming in weaker markets.

Amid the gloom, however, there will be pockets of opportunity for cash-heavy investors in discounted loans, distressed debt, raw land, apartment buildings and other niches, the report said. ...

"If you look back, there were tremendous opportunities available to anyone who would take the leap and buy properties at a discount from the [government-owned] Resolution Trust Corp. — and that set the stage for strong growth among REITs," said Robert Bach, chief economist with Grubb & Ellis Co., a commercial-real-estate-services and investment company in Santa Ana, Calif.

At the time, though, there were dire predictions "that there would be no need for another square foot of commercial real estate until about 2010 or 2015," which spooked investors, Mr. Bach said. "But people who bought properties back then did very, very well."

Nevertheless, the report throws cold water on any hope for a speedy turnaround. ...

"This is going to be the worst year since the 1991-92 industry depression," Stephen Blank, senior resident fellow for real estate finance at the Urban Land Institute, said in a webcast. "We expect to see drops in value, negative returns, sharp increases in delinquencies and foreclosures — it's a bleak picture." ...

"The private commercial markets need to correct; they're lagging everything else," said Jonathan Miller, a partner in Miller Ryan LLC, a real estate marketing advisory firm in New York, and author of the ULI/PWC report. "That [correction] is going to happen over the next 12 to 18 months." ...

Of the 50 metropolitan markets tracked, the study found only two — Dallas and Houston — where prospects for investment and development in 2009 were better than in 2008, thanks to their exposure to the energy industry. ...

In general, the report urges investors to sit tight and be patient "because the markets have yet to correct as much as they're going to," Mr. Miller said.

However, the report cited investment opportunities for those with cash and low leverage, noting bottom-fishing opportunities among distressed sellers and lenders, whose highly leveraged loans are upside down. ...

On the bricks-and-mortar side, rental apartment properties should continue to show strength due to the reeling housing market. Infrastructure and transportation projects are also good bets, the report said.

Mr. Miller added that residential lots and raw land should offer good investment opportunities over the next 12 months, but investors should avoid hotel and retail properties. "It's going to be ugly in retail," he said. ...

In a recent report of its own, The Goldman Sachs Group Inc. predicted that commercial real estate values will tumble 19%, and vacancy rates will approach 1990s levels. The New York firm recommends that investors avoid REITs with high leverage, near-term refinancing risk and a reliance on development and merchant building for growth. ...

The report predicted that the debilitated housing market will bottom in 2009, but not before pricing levels tumble to 2003-04 levels. Distressed Florida condos with ocean views could offer good long-term investments when they bottom sometime in 2009, Mr. Miller said.

Fitch Ratings Ltd. in New York thinks that 75% of the housing correction is already behind us and that prices may tumble only another 10% before hitting bottom in the next few quarters.

"2009 will be downer, and 2010 may not be much better, but maybe by 2011, a slow recovery will be under way," Mr. Miller said. "It all depends on the economy — we need a jolt."

E-mail Janet Morrissey at jmorrissey@investmentnews.com.