Commercial Real Estate Faring Much Better Than Its Residential Sibling

By now, the troubles in the residential real estate market are well-known. But the other half of the real estate market - commercial real estate - has been surprisingly resilient. Two measures of the commercial real estate market released data last week, and while it's not all champagne and roses, it is certainly a brighter picture than conventional housing ... for now.

Data from Standard & Poor's S&P/GRA Commercial Real Estate Indexes show that office property prices rose 2.3% in August and 13.1% for the one-year period ended August 31, making it the best performing sector of the market.

Although it was up 1.2% for August and 2.2% for July, the Apartment sector was the worst-performing sector for the 12-month period and was down 1.3%, reflecting its tie back to the residential housing market. Warehouses and Retail both gained more than 10% on the year. The worst-performing sector for the month of August was the Retail sector, which was the only one with a negative return; it was down 0.7%.

Among the regions - Desert Mountain West, Mid Atlantic South, Midwest, Northeast and Pacific West - the Desert Mountain West showed the least impressive performance for August, down 1.8%. However, all five regions posted positive performance on the year.

The National Composite index was up 1.1% for the month and 6.2% for the 12-month period. It's one-year performance has declined over the past two months from 6.6% in June. David Blitzer, Managing Director and Chairman of the Index Committee at S&P, noted that that commercial property price indexes were continuing their deceleration from an August 2006 peak.

The Moody's/REAL Commercial Property Price Indices cover quarterly results through the end of September, and suggest that the tide may have turned in the commercial real estate market as well. The national index covering all property types is released monthly and was down 1.2% for the month of September. Moody's warns in its November report that the data could represent an inflection point in commercial real estate values brought on by the current liquidity crunch.

In the third quarter, Apartments was the worst-performing of the four property types at the national level, down 1.0% from the prior quarter, followed by Offices, which were down 0.5%. Industrial properties, however, were up 3.0% from the prior quarter, while Retail properties were up 2.6%.

Comments

[ForrestGumpInvestments]

Everyday more Economist’s like Robert J. Shiller are expressing concern that the threat of a recession is coming, but there are plenty of other clues that we are facing unprecedented risks. Consider publicly traded Real Estate Investment Trusts ( REIT). Over the last few years most REIT’s performed extremely well. But the fundamentals are deteriorating and the trading values that took years to build could potentially be wiped out in as many months by the those nasty stock market vultures and fast buck artists commonly known as short sellers. Take Equity One (ticker: EQY) as an example of the perfect storm. Equity One is traded on the New York Stock Exchange. While Equity One’s exposure is nationwide it is based in Florida and so is a huge chunk of its portfolio. The double whammy facing Equity One is that unlike a diversified REIT it primarily invests in “retail” real estate. Equity One disclosed in the latest supplement to it’s quarterly report that its overall vacancy rate is already over 6%, but the shocker is the fact that the rate almost doubles (to a little over 12% vacancy) when the tenants shop is less 10,000 sq ft. The real danger for Equity One is that this group of tenants represents over 70% of Equity One’s shopping center revenue. When you consider that less than 30% of Equity One’s current shopping center tenants are Anchor’s (defined as having over 10,000 sq ft.) you really get goose bumps because at least the bigger retailers have the capital reserves to weather the storm. …And you thought only Realtors and builders had it bad. 

[Kunst]

As a business owner with multiple retail leases expiring soon, I can tell you that commercial real estate has weakened greatly in the Sacramento area. Vacancies and business closings are up, and rents have dropped substantially over the last year. I track CBG (I am short), WRI, and KIM. All are down 20% in the past 3 months. CBG is down 40% in the last 6 months. It isn't going to get better any time soon.

Commercial real estate will follow residential down the ugly path, partly for the same reasons (e.g., overbuilding on excessive credit) and partly due to the economic "slowdown" which has clearly already started. CBG is being hit first and harder because it is a broker, dependent on new leases. KIM and WRI are shopping center operators. Since leases turn over on a multi-year schedule, the impact on them is slower. When things turn up, CBG will benefit first for the same reason. But don't hold your breath.