Commercial Real Estate: The Gathering Storm

Commercial real estate is a house a cards about to collapse on multiple fronts for deeply structural reasons.

Correspondent Thomas H.submitted this fascinating story: 'Pop-up' stores are becoming an overnight sensation. (Los Angeles Times) The basic idea is that retailers are not signing 5-year leases anymore--they're signing 20-day leases for 'pop-up' stores which have the lifespan of an insect and low costs for retailers seeking to unload discounted inventory in a hurry.

The model has been well-established with "holiday theme stores"--retail operations which sell goods aimed at a specific holiday such as Halloween for a few weeks prior to the holiday. (Never mind that the Halloween frippery is massively overpriced--doesn't anyone make their own costumes any more?)

The real surprise is major retailers such as The Gap (GPS) and Toys R Us are using the "pop-up" model:

These quickie retail operations -- known as pop-ups -- are showing up throughout Southern California and around the nation, filling in the gaps at recession-battered shopping centers for a fraction of the regular rents.

Once limited to seasonal shops and dusty liquidation centers, pop-up stores are now being opened by some of the nation's biggest retailers.

It's a trend that could reshape the nation's retail landscape if it continues, diminishing the power of commercial landlords and making it easier for merchants to test new locations and products with little commitment.

Gap Inc. recently opened a pop-up shop on trendy Robertson Boulevard to promote its new premium denim line; celebrities including Halle Berry and Ashlee Simpson-Wentz turned out to the shop's launch party. Toys R Us Inc. is setting up about 80 temporary toy shops nationwide, including several at upscale malls previously unavailable to the chain. J.C. Penney Co. touted its back-to-school offerings through interactive pop-up displays in half a dozen Southern California malls.

The end of the recession, he predicted, would not necessarily bring an end to the model.

Uh, what "end of the recession"? Just in case retailers didn't get the message: Mad as hell, consumers dump credit cards; Balances tumble as fury toward issuers swells.

Credit-card debt dropped the most, falling 13.1%, or $9.91 billion, to $899.41 billion. It was the 11th uninterrupted month of declines, the longest on record. See full story.

With unemployment at a 26-year high of 9.8%, many consumers have no choice but to tighten their belts. But more and more, consumers are closing their own accounts and choosing not to use credit cards because they're just plain angry.

"There's an enormous amount of backlash against the banks," said Dennis Moroney, research director at Tower Group. "It's like in the movie 'Network,' people are saying, 'I'm mad as hell and I'm not going to take it anymore.'"

Credit-card holders are so irritated that 32% of them told Consumer Reports in a recent survey that they have paid off or closed a card in the last 18 months. Half of those who canceled did so because they were peeved by recent actions credit-card issuers took, such as cutting limits, hiking interest rates, jacking up fees or imposing new charges.

At the risk of being tiresome, let's go over the foundation of the U.S. economy once more:

1. Consumer spending is 70% of GDP.
2. Expanding credit and borrowing are the lifeblood of consumer spending.
3. Consumer collateral (housing, income, stock portfolios, etc.) has been gutted, greatly diminishing the foundation of future borrowing.
4. Banks are functionally insolvent and are not lending as they did during the bubble boom.
5. Millions of Baby Boomers have realized that their current assets and savings enable a retirement in:

A. a sturdy cardboard box

B. a camper/20-year old RV on "The Slabs" (or equivalent)

C. Aunt Matilda's house if Auntie has the good grace to croak off fairly soon.

Thus this is no "dip in consumer spending"--it is a generational sea change with no end in sight.

Not only are consumers increasingly unable to borrow or unwilling to do so, but much of the overbuilt retail sector sells items which are superfluous (and that's the polite description). I have prepared a graphic depiction of the earthier truth:

It's not just retail that is doomed, of course; the hotel/hospitality sector is massively overbuilt and overleveraged. Everyone, it seemed, was chasing the "luxury" and business traveler. Now that the cold wind of reality is rising, owners are discovering that the hotel they bought for $250 million with a $230 million mortgage is worth about half that amount--at best: Hawaii Hotels Face Fewer Visitors, More Debt.

As for commercial office space--ponder this data point. It was recently announced that Internet darling Twitter leased more space in San Francisco as it was expanding its 30-person staff to maybe as high as--gasp!--100.

Let's follow that to its conclusion: the "hot headline" tech companies have vanishingly few employees, and a significant majority of them can work partly from home or from some other remote location. They don't need a cubicle or a conference room or an office at all.

Even mighty Google (GOOG) employs about 16,000 people globally--perhaps a tenth of a major industrial company like GE and not much more than the student populace of a moderate-sized state university.

And many of these people can work remotely as well. The truth is you don't need huge office towers for the new economy.

As for smaller space--please see End of Work, End of Affluence III: The Rise of Informal Businesses (December 10, 2008) and Trends for 2009: The Rise of Informal Work (December 30, 2008). Thousands of small businesses can be operated out of home offices and garages, and the work done at clients/customers' homes.

We can summarize the commercial real estate market graphically:

Comments

[58robbo:]

there will be no storm! if the residential market is anything to go by, banks will just repo commercial re, board it up and that will be that! the property taxes and maintenance are minor expenses yet the value of this worthless real estate will appear on their balance sheets at 2006 prices. where is the storm now? it's almost as if you still believe that the insolvency rules which apply to you and me, apply to the banks!

Oct 22 11:46 AM

[ryanclarke:]

For the past ten years in the U.S. most of the construction jobs went into building strip malls and restaurants and hotels and resorts and casinos and ... houses for people to work in strip malls and restaurants and hotels and resorts and casinos ... only problem is the jobs in strip malls and restaurants and hotels and resorts and casinos don't pay enough to afford the house. The economy I've just described is based on cheap oil and practically free private transportation. If Wall Street doesn't become bearish this winter look for inflation to get out of way out of hand next spring and thus FORCE Wall Street to get bearish in the summer of 2010.

Oct 22 11:51 AM

[Donald Ingram:]

Charles - Another thought provoking article.
I would also include the loss of tax revenue to city, county and state, plus the Federal government.
Corporate tax receipts down 54.4%.
Personal income tax down 20.1%
This does not include the loss of property taxes, sales taxes, zoning fees, permit fees, license fees, etc.
Look out for the impending implosion from worsening state, county and city budget crises. The coming complete collapse of the commercial real estate sector will be the beginning of the "new normal". Welcome to the "jobless recovery"!

Oct 22 01:12 PM

[Tony Petroski:]

Mr. Smith. If I interpret your article correctly, all is doomed. If you are right, have a nice day. If you are wrong, there are still possibilities.

From the article:

"The model has been well-established with "holiday theme stores"--retail operations which sell goods aimed at a specific holiday such as Halloween for a few weeks prior to the holiday. (Never mind that the Halloween frippery is massively overpriced--doesn't anyone make their own costumes any more?)"

It is a model. Halloween comes to mind. Less so for Christmas. What are the other holidays that theme stores cater to?

The author:

"At the risk of being tiresome, let's go over the foundation of the U.S. economy once more:"

Why warn us if you're going to be tiresome anyway?

The author:

"Millions of Baby Boomers have realized that their current assets and savings enable a retirement in:
A. a sturdy cardboard box

B. a camper/20-year old RV on "The Slabs" (or equivalent)

C. Aunt Matilda's house if Auntie has the good grace to croak off fairly soon."

Young man, the one who inhabits Mr. Smith's body:

Grow up. It may be true that millions of baby boomers will have to retire into a carboard box, but some of them are still cheering for Aunt Matilda and they want her to live, not to croak off soon.

Oct 22 01:41 PM

[Jimmy K:]

He's right... here in South Florida- they turned two old mega-Circuit City stores into "Halloweentowns" I imagine they'll close up Oct 31.

Oct 22 04:13 PM

[Donald Ingram:]

Jimmy - they are known as "pop ups". A new phenomena for the new reality. Get ready to see a bunch of pop ups for the coming Xmas shopping season. They will be here today and gone tomorrow. Pop goes the weasel!


On Oct 22 04:13 PM Jimmy K wrote:

> He's right... here in South Florida- they turned two old mega-Circuit
> City stores into "Halloweentowns" I imagine they'll close up Oct
> 31.

Oct 22 08:38 PM

[The Dark Years:]

A worthwhile read. Enjoyed the graphic displays. Fundamental point is correct.

Donald Ingram and ryanclarke had good comments.

My view from Orange County California would be in agreement in general with the author. Housing values exploded here in ground zero between 2001 and 2006 and then tanked. Commercial property did the same. All of the excessive faith in a forever increasing market caused normally rational and conservative people to go out and leverage and buy before they lost their share of the pie. I know many individuals who have lost their jobs and homes and have little option except to downsize and restructure their lives, often by moving to less expensive states. Recovery, if it ever comes is a long way off for most Americans. We just do not recognize the magnitude of the problem, nor crucially it's true source. The success of Suburbia is based on cheap transportation of virtually everything, and that means cheap oil. While there are many non believers in Peak Oil as an affordable resource fundamental to our way of life the evidence is that the last upward spike in oil pricing was an element in the collapse of the housing market. As the oil prices returned to lower levels we began to return to business as usual. Those left behind because their credit was destroyed, their saving disappeared, and they have no prospect for a job at anywhere near their original pay levels are unlikely to recover to buy another house. Nor will they be buying at Maceys or any high end outlet store. When, not if oil prices again spike dramatically the devastation will be even greater. For a view of the future everyone ought to read James Howard Kunstler's book about the future, he has termed The Long Emergency.

Oct 23 10:20 AM

[John Lounsbury:]

Horrors! I'm going to have to keep the Christmans gifts I get this year. There will be no store to go to for exchanges - it will have popped back down. So if you see me with pants that fall off my hips or cuffs that are halfway to the knee, you'll know why.

Oct 23 12:03 PM

[robert.b.fe...:]

Excellent article, hat tip to the author. With all of the problems we already have team Obama seems intent on exacerbating the situation. With knee cap our trade worming it's way through congress and the EPA threatening new regulations energy costs are going to go up. This will result in the costs of everything else to rise while driving productivity down. CRE will get even more precarious going forward. Taken all together this is a recipe for disaster!

Oct 23 12:24 PM

[doubleguns:]

Washington parties on. Not a care in the world for the citizens of this country.

As our country gets reshapped into a poverty stricken has been, I hope the sheeple figure out that washington needs reshaped if we want to fix this problem. goooh.com

Oct 23 12:39 PM

[The Geoffster:]

Don't forget the "revenue" bonds that are tied to tax receipts from these failed shopping centers.

Oct 23 12:48 PM

[tripleblack:]

COmmercial real estate should be the success story of this whole financial disaster, the portion of the economy that skirted the pit, but hung on by its fingernails JUST long enough for the tide of disaster to ease, and leave them standing and poised to survive...

Except the rescue team from the government got lost, and ended up "stimulating" a bunch of foreign dollar carry traders long after the fact.

Wow. What a shame. Too bad we hired a bunch of wackos to run things who can't see a road map even when its tatooed to the inside of their eyelids. Maybe its the rose-tinted sunglasses...

Oct 23 03:10 PM

[Albertarocks:]

On Oct 23 03:10 PM tripleblack wrote:

> Wow. What a shame. Too bad we hired a bunch of wackos to run things
> who can't see a road map even when its tatooed to the inside of their
> eyelids. Maybe its the rose-tinted sunglasses...<

Americans keep slamming themselves for putting morons into power when it isn't truly their fault. The problem lies in the fact that the American people are brainwashed by that god damned mass media into basically having no choice "but" to hire morons. The entire notion of Democrat/Republican, left/right, red state/blue state is a false paradigm designed to create polarity. Divide and conquer. The media is a propaganda machine. It's a mind control machine. As long as it's owned by a very few oligarchs, and used as a tool of distraction and misinformation, it represents the greatest threat to the world currently in existence.I urge Americans to stop blaming themselves and just grab the enemy by the throat. And smile in utter pleasure while you do it with the knowledge that in doing so, you're regaining control of your own minds.

Oct 23 03:20 PM

[Swashbuckler:]

Are you married?


On Oct 22 04:13 PM Jimmy K wrote:

> He's right... here in South Florida- they turned two old mega-Circuit
> City stores into "Halloweentowns" I imagine they'll close up Oct
> 31.

Oct 23 03:50 PM

[Rhino Realty:]

I think I shopped at the "House of Crud" last week...I bought a sack or crud and I got home and fed it to my dog. He rolled over dead. I then went over and gave some to my neighbor who was irritating me with his loud dog. It's pretty quiet around here now.

Oct 24 12:18 AM