Commercial Real Estate: The Next Shoe Drops

by: Jim Kingsland

Lots of shoes are dropping these days. This must be a shoe closet that Imelda Marcos would be proud of.

The Midwest led the biggest-ever drop in the national quarterly commercial real-estate index compiled by the Society of Industrial and Office Realtors. The national index dropped nearly 4.5 points, to 113.7, for the summer of 2007. That is the weakest score since SIOR began compiling the index nearly two years ago. The Midwest index plunged more than 10 points, from 104.6 in the spring to 94.5 in the summer.
Read more: Midwest Commercial Index Tanks.

Yes, there have been excesses in the commercial real estate space as well. A friend (from Williamsburg, VA) and I were discussing the quandry that these commercial real estate operators are finding themselves in, especially in the big cities like Chicago. He made this astute observation:

IT IS EVERY WHERE YOU HAVE SEEN MAJOR NEW DEVELOPMENT, NOT JUST CHICAGO. IN SLEEPY LITTLE WILLIAMSBURG VIRGINIA WE HAVE 40% MORE STORES DEVELOPED, IN JUST 4 YEARS TIME. WILLIAMSBURG HAS BEEN HERE FOR OVER 400 YEARS. WHY DO WE NEED SO MANY NEW BIG BOX STORES IN JUST 4 YEARS TIME?

Back in July, when the credit mess was really starting to take off, another friend sent me an email about commercial real estate, and noted a troublesome situation involving yields of REITs vs 10- year treasurys:

...regarding the credit seize up this past week--commercial reitshave been absolutely hammered BUT...they still trade with a yield lessthan the 10 year Treasury, whereas the ten year historical spread hasbeen 3%.To put this in concrete terms, Simon Property Group, the largestcommercial reit, closed Friday at $84.90 with a yield of 3.80%. If itwere trading at its historical ten year spread to Treasury, the marketprice would be ....$42.50. And once these spreads flip (as this one has), they have a tendency to overshoot, don't they?

Remember, that's a snippet from an email that came to me back in early July. Simon (NYSE:SPG) yields even less now at 3.49%, while the 10-year treasury yield is at about 4.4%.

Expect a lot more news - negative news - from this part of the real estate market.