Why Commercial Real Estate Will Recover Faster

Key quotes from Investors Real Estate Trust FQ209 conference call (IRET) on the state of commercial office and retail space in the midwest:

Is it the media drumbeat?

IRET has not, as yet, experienced a meaningful and direct impact from the national economic meltdown.

Many of our commercial tenants are facing a difficult business environment and we realize that this will eventually impact our commercial sectors. However, at this point our financial results from our office, industrial, and retail portfolio have not deteriorated in a significant amount.

I have been with IRET for only ten years. I have certainly seen worse apartment and commercial real estate conditions in that time. However, never do I recall the current level of predicted gloom, doom, and pending disaster. The conditions in IRET’s present markets do not match the news reports.

Q: You have been in the business a very long time. Is this as bad as warned?

A: Not yet, it is not. Certainly our company has been through more severe downturns in the 80s and the 90s that took down Trammell Crow and other long-standing real estate companies and we had no difficulty in that period, and I would say at this point we are still not seeing any problems.

Healthcare, elderly care facilities, multi-family are ok relative to commercial retail or office:

We anticipate continued stability in the performance… of our medical office and assisted living segment, which together represent just over one-half of our real estate assets.

While it hasn’t happened yet, our commercial, office, industrial, and retail segments in metropolitan markets are likely to feel the impact of the weakening economy.

Commercial:

Just to be absolutely sure we are not surprised by changes in the commercial debt market, we have started the process of placing new over [newly] debt on all commercial loans maturing in the next 18 months... To simply hedge against further deterioration in the commercial market.

Contrary to previous downturns, on the commercial side we are still experiencing demand for space across all segments, including retail and commercial office, on a limited basis... There is activity by the tenants in the markets for new or expansion space.

[The] commercial office segment is under a significant amount of negative economic pressure. Unlike retail, there is still fair-to-good [commercial office] demand among users. Additionally, the economics of retaining and securing commercial office tenants still works economically as contrary to the prior office downturns in 2002 to 2004.

There is not much new development space coming online. Most competition is from existing vacant space or newly vacant space due to downsizing or business failures. I expect those rents and occupancy to decline through 2009 but absent a very severe and prolonged downturn, given the lack of development and tighter credit markets, the rebound in commercial office demand could be very rapid.

Retail:

The retail segment is under the most stress, even though our portfolio is mostly destination retail in more established locations. We have improved occupancy slightly over prior periods, but at the expense of net rents. We expect further contraction of existing tenants as the current economic environment is forcing more store closings and it appears that the rent levels and transaction costs to convince retailers to remain in or enter locations makes no risk-adjusted sense at this time.

Just how bad is it?

In certain downturns [commercial leasing] tenants will expect or demand economic terms on their leases that just don’t make sense long term but are being driven by the current economic environment.

In past market downturns we made a conscious decision to reject those deals, having full faith and confidence in the market and our buildings. Currently what we are doing is we are taking a step back from that long-held strategy and we are saying is this is as bad as warned, does it make sense to take what is available now, even though we don’t necessarily view it as the right thing to do long term, what if?

We may shift our strategy to, in essence, match the market, become more aggressive in an attempt to secure any available commercial tenants that are looking for space and to renew any tenants that are in our buildings.