In mid-November, the Connecticut chapter of the CCIM Institute holds its semi-regular introductory course to commercial real estate analysis for investment purposes.
In light of market events, the curricular materials are due for an update.
As layoffs mount and banks attempt to minimize exposure to bad loans on the books, real estate professionals predict commercial-office values will erode in the metropolitan New York City area. The overriding question becomes how submarkets like Fairfield County and Westchester County, N.Y., will respond as values ebb in Manhattan; and the domino effect on outlying areas like the lower Hudson Valley and New Haven County.
The slowing economy had yet to move commercial rents down significantly in the third quarter in Fairfield and Westchester counties, according to Cushman & Wakefield, a commercial property broker. The commercial office vacancy rate was 14 percent in the third quarter in FairfieldCounty, up from 13.2 percent three months earlier.
“Several of our clients are in the deal-making mode, but they are going about it in a pragmatic and businesslike fashion,” said James Fagan, senior managing director of Cushman & Wakefield. “They oftentimes are making decisions that are long-term in nature and they are trying their best not to be influenced by short-term capitulations in the market.”
The Manhattan commercial office market, however, is in for a “beating,” according to the “Emerging Trends” report in late October from PricewaterhouseCoopers L.L.P. and the Urban Land Institute, which interviewed more than 600 real estate investors, developers, lenders, brokers and consultants.
“Many property owners are drowning in debt, lenders are not lending, and for many (owners) property income flows are declining,” said Stephen Blank, a senior resident fellow with the Urban Land Institute who co-authored the report. “There is an unprecedented avoidance of risk. Only when financing gets restructured will pricing reconcile, giving the industry a point from which to start digging out of this hole.”
That point could come as early as 2010, the study predicted, with financial institutions speeding up the process by using auctions to move bad loans off their balance sheets.
When the bloodletting is over, bargain hunters with ample cash and low debt will be in position to capitalize, albeit in an environment in which lending guidelines are strict and real estate funds will use new investment models for determining returns.
At the time of the report in mid-October, the authors predicted that the then-low U.S. dollar would entice sovereign wealth funds and overseas private equity funds to scoop up real estate in the United States on the cheap, particularly so-called trophy properties in major cities that could in turn drive more domestic buyers into the suburban markets like Fairfield and Westchester counties. Since then, however, a stampede to the relatively safe haven of U.S. Treasury bills and bonds, in turn sending the dollar up sharply against the euro, and introducing uncertainty into previous assumptions on the impact of currency rates on commercial real estate purchases.
Analysts with Grubb & Ellis predict Manhattan building prices will lose 20 percent of their value over the next two years, as landlord rent demands decline 7 percent annually over that stretch. Over the first nine months of the year, more than 2 million square feet of space has hit the Manhattan market, and if Wall Street job losses total 40,000 layoffs in the coming year as predicted by New York officials, that could result in at least 9 million more square feet of space becoming available.
That in turn would elevate the vacancy rate in Manhattan from the current 5.7 percent figure closer to 9 percent, in past markets a point of equilibrium in which landlords and tenants have equal leverage, according to Grubb & Ellis. A state of equilibrium in New York City might destabilize suburban markets, however, which have benefited from companies abandoning the Big Apple to escape sky-high rents and congested commutes.
If there is a silver lining, it is that the dearth of commercial real estate construction that contributed to rapidly rising rents this decade may help keep commercial office rents steady, with no widespread glut of space apparent at present.
“The growth that Fairfield (County) has seen over the past years will likely slow down, but it is also in a better position than in past recessions,” said Larry Kamnitzer, a research analyst with Grubb & Ellis, in a note analyzing current market conditions.
