Office Building Vacancies In Major US Cities Rising Rapidly

Source : The Business Times, January 6, 2009

Rental incomes and property values seen sliding further

(NEW YORK) Vacancy rates in office buildings exceed 10 per cent in virtually every major city in the country and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.

Towering liabilities: Already, US$107 billion worth of office towers, shopping centres and hotels are in some form of distress, ranging from mortgage delinquency to foreclosure, says a Real Capital Analytics report

With job cuts rampant and businesses retrenching, more empty space is expected from New York to Chicago to Los Angeles in the new year. Rental incomes would then decline, and property values would slide further. The Urban Land Institute predicts that 2009 will be the worst year for the commercial real estate market 'since the wrenching 1991-1992 industry depression'.

Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages soon. The persistent chill in lending from banks to the credit markets will make that difficult - even for borrowers who are current on their payments - setting the stage for loan defaults.

The prospect bodes poorly for banks, along with pension funds, insurance companies, hedge funds and others holding the loans or pieces of them that were packaged and sold as securities.

Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying group in Washington, is asking for government assistance for his industry and warns of the potential impact of defaults. 'Each one by itself is not significant,' he said, 'but the cumulative effect will put tremendous stress on the financial sector.'

Stock analysts say that commercial real estate is the next ticking time bomb for banks, which have already received hundreds of billions of dollars in capital and other assistance from the federal government.

Big banks - such as Bank of America, JPMorgan Chase and Morgan Stanley - each hold tens of billions of dollars in commercial real estate securities. The banks also invested directly in properties.

Regional banks may be an even bigger concern. Over the last decade, they barrelled their way into commercial real estate lending after being elbowed out of the credit card and consumer mortgage businesses by national players. The proportion of their lending that is in commercial real estate has nearly doubled in the last six years, according to government data.

Just like home loans that were pooled, then carved up and sold to investors as securities over the last two decades, commercial property loans were repackaged for the financial markets. In 2006 and 2007, nearly 60 per cent of commercial property loans were turned into securities, according to Trepp, a research firm that tracks mortgage-backed securities.

Now that the market for those securities has dried up, borrowers cannot easily roll over loans that are coming due.

Many commercial property owners will face a dilemma similar to that of today's homeowners who cannot easily get mortgage relief because their loans were sliced and sold to many different parties. There often is not a single entity with whom to negotiate because investors have different interests.

By many accounts, building owners have been caught off-guard by how quickly the market has deteriorated in recent weeks.

Rising vacancy rates were expected in Orange County, California, a centre of the sub-prime mortgage crisis, and New York, where the shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded from the economic downturn until recently by skyrocketing oil prices and expanding energy businesses. In Chicago, brokers say that demand has dried up just as new office towers are nearing completion.

'The economic recession is so widespread that we believe virtually every market in the country will see a rise in vacancy rates of between 2 and 5 percentage points by mid-2009,' said Bill Goade, chief executive of CresaPartners, which advises corporations on leasing and purchasing office space.

There is no relief in sight for Orange County, where sub-prime lenders and title companies once dominated the market, but are now shedding space because their businesses have dried up, and big banks are now shrinking because of a wave of mergers. The vacancy rate has soared from 7 per cent at the end of 2006 to 18 per cent, a rate that the Tampa area should match this month, local real estate brokers say.

In New York, where rents had risen the highest as financial companies gobbled up office space, vacancy rates are floating above 10 per cent for the first time in years.

What looked like the worst possible case a few weeks ago for Chicago now appears to be the most likely outcome, said Bill Rogers, a managing director at Jones Lang LaSalle, a real estate broker. The vacancy rate, which was fairly stable at 10 per cent, is rising quickly and could hit 17 per cent this year, he said. 'A lot of companies are trying to shed excess space ahead of what is expected to be a worse market in 2009,' he said.

Newmark Knight Frank, a real estate broker, expects the vacancy rate in Dallas to rise to 19 per cent from 16.3 per cent.

Houston, like Dallas, held up while many other cities were showing the strains of an economic slowdown. But job growth and the brisk business of oil and gas exploration have come to an abrupt halt.

Vacant or unfinished shopping centres dot the highways. Among the 8.4 million square feet of office space under construction or recently completed in the metropolitan area, 80 per cent has not been leased. As a result, the vacancy rate is 11 per cent and rising.

Effective rents, after free rent and other landlord concessions, have already started to fall and are expected to decline 30 per cent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts. That is making it all the more difficult for owners, who projected ever-rising rents when they financed their office buildings, hotels, shopping centres and other commercial property. Owners typically pay only the interest on loans of five, seven or 10 years and refinance the big principal payments necessary when the loans come due.

Without new financing, owners will have few options other than to try to negotiate terms with their lenders or hand over the keys to banks and bondholders.

Among commercial properties, the most troubled have been hotels and shopping centres, where anaemic sales and bankruptcies by retailers are leading to more vacancies, and where heavily leveraged mall operators, such as General Growth Properties and Centro, are under intense pressure to sell assets.

The Real Estate Roundtable sees a rising risk of default and foreclosure on an estimated US$400 billion in commercial mortgages that come due this year.

In recent weeks, a group led by the New York developer William Rudin has pleaded with Treasury Secretary Henry Paulson, Senator Charles Schumer and others to have the government include commercial real estate in a new US$200 billion programme designed to spur lending.

Already, US$107 billion worth of office towers, shopping centres and hotels are in some form of distress, ranging from mortgage delinquency to foreclosure, according to a report by Real Capital Analytics.

New York, the biggest market by far, leads the pack with 268 troubled properties valued at US$12 billion. But there are 19 more cities, including Atlanta, Denver and Seattle, with more than US$1 billion worth of distressed commercial properties. - NYT