Find the Bottom

Commercial real estate is finally feeling the pain. Sharply.

Rental vacancies are on the rise across the region, foreclosures and short sales are up, lease rates are dropping and declining sale prices are starting to make commercial look more like the residential market of the past few years.

The quick change has pushed property experts into one of two generally pessimistic camps: those who think the market has more to fall and those who think it is nearing bottom. For more hopeful news, most observers say you have to look to the end of 2010 or beyond.

Jeff Sweeney, president of Grubb & Ellis|Commercial Florida, is in the somewhat optimistic camp that Florida's commercial real estate market is close to or at its bottom. But he's not predicting a speedy bounce off the bottom.

“I'm fearful this bottom may be broad,” he says. “But I don't think we'll see another 40% reduction in rates and values.”

A silver lining for the uncertain economy and low rental rates has been an increase in the volume of leasing.

“What we're seeing is a stronger emphasis on leasing than we have seen,” says Loyd Robbins with the Sarasota real estate brokerage Harry E. Robbins Associates Inc. “On the sales side, even though there are great opportunities it remains sluggish. Businesses that have historically been buyers of flex space in industrial condominiums — as the markets has started tightening down — have been looking for places to lease.”

Leasing is a response by many companies fearful of long-term commitments. Ian Black, president of Sarasota-based Ian Black Real Estate attributes this cautiousness to continued uncertainty about the economy and availability of business credit.

Lease rates have fallen dramatically. Black puts the lease rate in some areas of Sarasota at levels not seen in 20 years, while lease rates along the high-traffic Tamiami Trail are down to their lowest levels in a decade.

“We've seen some panic and some owners have cut rates too far,” Robbins says. “Those extremely low rates create almost a gas war where other landlords felt they had to follow suit just to compete. It's a concern for landlords because with inflation even the best of tenants could put them behind the curve and start costing them money.”

That tightening struggle between rental rate and covering a commercial property owner's expenses has some experts like Randy Mercer, a founding partner of CB Richard Ellis, Fort Myers-Naples, seeing an end soon to the lease rate decline — at least in some sectors.

“I'm actually encouraged,” says Mercer. “I really see stabilization, and I'm pretty excited about that. Of course, it's not in every submarket.”

Mercer points to pockets of improvement for office space that are popping up in Fort Myers. CB Richard Ellis statistics show that in the third quarter, Fort Myers South actually had rental rate growth of $1.26 to $17.01 per square foot compared to last year and absorbed 9,796 square feet of its excess inventory. Similarly, Fort Myers North shrunk its vacancy rate from 26.5% to 19.8%; absorbed 31,842 square feet of existing inventory and saw its base rent grow $1.13 to $12.15 per square foot.

Mercer also sees improvement in higher end office space, which he describes as a “flight to quality.” With rents down, companies are choosing to upgrade the class of their space for close to the same rent rate.

But while he sees improvement in areas of Fort Myers, which declined earlier than other regions, Mercer expects Collier County office to continue to fall through 2010.

Similarly, since industrial real estate took such a large hit much earlier with the decline of the residential market, Mercer expects that its attrition has stabilized.

“I'm not saying whether or not it will be the first one to come back,” he says. “We are going to need jobs to be created to fill up that space, and some of those are lost for good.”

He sees an ongoing challenged for the next five years. “I think 2010 will be a flattening year for probably everyone except retail, which will have another bad year,” he says.

Retail has its owns problems, including a more recent decline and extremely large vacancies in many cases.

One significant user group, banks, are either choosing to pull themselves back from adding new branches for balance sheet reasons or finding resistance from
the FDIC to expansion. Kingan Commercial Real Estate's Richard Kingan, who is marketing Wachovia's unneeded bank branches along Florida's West Coast, says he's finding vastly depressed values for the buildings.

“Of the 14 we have listings on, one is going to be a gas station, another is going to be a medical office,” Kingan says. “Only one of them [so-far] is going to a bank.”

Commercial land is in for a rough ride mirroring much of residential lands' decline, according to Randy Thibaut, owner and CEO of Fort Myers-based Land Solutions Inc.

“We've seen residential land bottom out in 2009, but there won't be much increase in values in 2010,” he says.

Expect more decline in commercial land in 2010, he says, because there's an oversupply from new foreclosures and short-term loans coming due.

“I see more optimism on the residential side,” Thibaut says. “We see some builders starting to dip their toe into the water thinking about putting new product in the ground.”

Further delaying a commercial recovery is uncertainty on the future supply. Banks continue to accumulate distressed commercial real estate holdings, but much like with residential, they are being slow to unravel those holdings. At the same time, the costs associated with distressed and bank-owned properties are also draining bank reserves, limiting the availability of business and real estate financing.

“The lenders in today's market aren't dumping their product yet,” says John Burpee, chairman of Seminole-based NAI Tampa Bay. “A couple of them are telling us they would rather hold the assets until the market recovers.”

But, when lenders do release even a small portion of their product it can move the market. The apartment market was relatively quiet this year until several distressed sales started happening in the second half of the year, according to Darron Kattan, a partner with the Tampa-based Franklin Street Real Estate Services.

“Banks and [real-estate investment trusts] are the main sellers,” says Kattan. “Aimco and Equity Residential were the two REITs with balance sheet issues. The banks sales have primarily been fractured condo communities. Banks can't write down the losses of all their real estate today, otherwise nearly all of them would collapse.”

So the banks end up prolonging the write down.

The upside of the current residential turmoil for multifamily property owners is that the difficulty in obtaining new home mortgages and the lack of other options for foreclosed homeowners should increase the pool of renters. While bank-owned or otherwise distressed housing is still keeping multifamily rental rates lower, Kattan expects this to change in the next two to three years as the job market recovers.

“I really see [the commercial real estate market] as a return to fundamentals,” Kattan says. “People are looking for first-class locations and quality. They are looking at primarily infill and to be in as good a market as they can be.”

Tom Woodyard, head of the Fort Myers-based real estate brokerage Woodyard & Associates, expects the commercial recovery could start out soon, similar to the early 1990s after the savings and loan crisis.

“We starting to see a lot of interest from foreign investors,” he says. But instead of Japanese, the interest is coming from the China, Germany and some from Israel, he says.

“We're already seeing this in the first tier markets. They're already here learning the market — a lesson they learned from the Japanese, who overpaid,” Kattan says.

Robbins predicts that when the general business economy improve, the commercial real estate market will quickly recover to match it.

Until then, all the real estate experts were uniform in saying that for buyers with the financial wherewithal and a nose for good real estate deals, it is one of the greatest opportunities in the last decade to buy discounted properties.

To see Commercial Real Estate by the numbers, download the report here. BytheNumbers1110.pdf