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Continued Decline in Economy Across All Sectors Batters Real Estate Industry

Real estate continues to be battered by a falling economy and credit crisis. The pessimistic attitude currently gripping the commercial real estate markets shows no signs of abating as we head into 2009. Though some metro areas will continue to experience distress due to overbuilding, plummeting demand will be the primary cause of market turmoil.

In terms of the retail sector, vacancy rates at U.S. malls and shopping centers continued their steep rise in the third quarter as slumping sales forced retailers to close stores. Malls are seeing their highest vacancy rate since 2001, according to data released by real estate research firm Reis Inc. For shopping centers, the rate of vacancy is the highest since 1994. In contrast, the apartment market remained one of the most healthy real estate markets in the third quarter, benefiting from the struggling housing market. Many would-be buyers, unable to get mortgages or worried about the darkening economy, are renting apartments instead. In the top 79 U.S. markets, apartments posted a slight increase in the vacancy rate to 6.1%, up from 6% from the previous quarter, and a rise in rents of roughly half a percentage point, according to Reis.

Until recently, most commercial landlords had struggled with the financing drought, but the so-called "fundamentals" of their properties – vacancy rate, rent and expenses – remained healthy. Now that is changing. Retailer closures outpaced new leases by 2.8 million square feet in U.S. strip centers in the third quarter, the third consecutive quarterly net decline. It is the first nine-month period of so-called negative net absorption since Reis started tracking the data in 1980. The combined vacancy rate for malls and strip centers in the third quarter was 8%, up from 7.8% in the second quarter. Vacancy tends to be higher in strip centers during economic slowdowns because they have more independent, local tenants, which are more vulnerable to drops in sales than are the national retailers found in malls.

By the end of 2008, unfavorable fundamentals will result in cumulative net rent losses in all property types, except apartment. Not surprisingly, given the dismal demand outlook, retail landlords are being hit the hardest on rent in 2008, with projected losses of 3.6% by year's end. Even in the apartment market, where year-end rent growth will remain positive, concessions are rising to the point where landlords will face diminishing effective rents. In 2009, the outlook will be even more pressing for all landlords. Apartment and warehouse properties will suffer 2% rent losses for the year, while rent losses in the office and retail sectors will exceed 5%.

In addition to a worsening fundamentals outlook, commercial real estate values are being further eroded by turmoil in the capital markets. These two forces will work in concert to batter values in the coming year. By the end of 2009, it is expected that values will drop 15%-20% from fourth quarter 2007 levels.

As in any market environment, the quality of the real estate portfolio is key as higher quality portfolios should show smaller declines in rent and vacancy. Many large scale owners with significant “Class A” properties are not entirely subscribing to “gloom and doom” market predictions. These landlords are emphasizing that, while they fully acknowledge the difficulties of the overall economy and the declining value of real estate, it is the strength of their portfolio mix and prime properties that will allow them to weather what is sure to be one of the toughest market challenges they will ever face. Tenants also have some good news in that landlords have little choice but to give their struggling clients various breaks and financial concessions to avoid losing them entirely and face the extreme difficulty of re-leasing the vacant space.

AccuVal understands that professionals in the real estate industry connect people with homes to live in and buildings to work in. A gigantic industry, real estate is core to the nation’s economy. Dips in the real estate market can have an enormous impact on all economic sectors. Interest rates and the availability of financing are critical to the purchase of land, homes and businesses and to real estate development. Learn about AccuVal's approach to valuing real estate and see how we have leveraged our expertise to help companies with real estate holdings in their portfolio.