This Year, Pain To Replace Gain

Nary a Bright Spot in CoStar Group’s First-Ever State of the Market/Industry Outlook

The pain felt throughout the U.S. housing market over the past two years is going to catch up with commercial real estate in 2009 when the country will begin to see spikes in office vacancy rates climbing as much as 300 to 400 basis points with many markets expected to experience severe negative net absorption. That was the assessment of Andrew Florance, founder and CEO of CoStar Group Inc., as presented in the company’s first-ever 2009 State of the Office Market review and outlook delivered this afternoon from its Bethesda, MD, headquarters and webcast to CoStar clients across the country. Florance’s presentation laid out the economics and fundamentals detailing the impact of the financial meltdown on commercial real estate, finding little upside to report with all indicators projecting continued:
Constraint in the credit markets,
Dearth of investment and construction activity,
Corporate space contraction, and
Falling property values.The outlook is now for the current recession to take a higher toll, for a longer time, on commercial real estate than did the dot.com bubble burst of 2001-2002. Rather than try to reproduce the entire presentation or beat the dead horse that is the economy, here is recap of just some of the highlights.
ContractionUnlike in previous recessions in which the commercial real estate industry participated in its own demise through gross overbuilding, the current downturn was precipitated by an unparalleled run up in housing values and the subsequent burst of that bubble. Housing values continue to fall precipitously. Overlaying commercial office values with housing values, Florance showed that, while commercial values also experienced a rapid ascent, those values peaked at substantially lower levels than the housing peak. Also based on historical norms, it appears housing values still have a ways to fall, while commercial office space values have already returned to much closer what are their norms. That doesn’t mean that office values could hold at the level because clearly the market dynamics are working against them. The S&P 500 Index is down 40% from its highest levels and lower than what is has been in five years. The index is important to commercial real estate because without increasing stock prices, corporations will be less likely to expand. The lack of expansion is major drag on office space absorption, Florance said. In addition to stock price declines, initial public stock offerings that fuel the growth of newer firms have dried up completely this year. Corporate borrowing outside of federal government-assisted bailouts also has fallen to record lows - less than $25 billion/month in the most recent quarter compared to more than $400 billion just 18 months ago. The commercial mortgage backed securities (CMBS) markets also dried up completely in the fourth quarter and thus banks - were they even making loans - have nowhere to market or sell those loans to the secondary markets to make room to do more lending. The employment picture is also dismal. The U.S. economy already lost more jobs (1.9 million) in 2008 than during the dot.com bubble burst in 2001-2002. Economy.com is forecasting as many as 3.1 million job losses in 2009.
Inventory BuildupOne small bright spot to current commercial real estate conditions is that there was very little surge of new supply leading up the recessionary environment starting in December 2007. Commercial office space is entering the downcycle from a position of relative strength. Nor is CoStar forecasting much additional in the way of new supply coming onto the market through 2012. However, the office supply inventory is going to increase. In fact, the supply of available and vacant office space is beginning to increase as there is currently virtually no absorption of excess space occurring. Vacancy rates have begun to tick up as projects already under construction are being completed. Combining the forecasts for job losses in 2009 and a dwindling supply of newly delivered space, CoStar is predicting that U.S. office vacancy rates could climb from a base of 11.1% at the start of last year to 15.1% in 2010. Some U.S. markets will be hit harder than others but all are projected to grow to double-digit vacancy rates in 2009 and 2010. CoStar is projecting that the Phoenix and Detroit vacancy rates could exceed 20%. Job losses are also projected to be heavy in South Florida, the New York Tri-State area and San Francisco and those markets will likely see fairly steep increases in their vacancy rates over the next two years. There won’t be any clarity to when the markets can return to normal until the peaks in vacancies and the valleys in prices and rents hit top and bottom. In the two previous recessionary periods of early 1990s and 2001, office inventors did not return to the market until it was clear that the deterioration in conditions had stopped. And right now, the volume of investment activity is at or near its historical norms. So while the outlook for 2009 is grim, it is likely that the market for office building investments will remain flat through 2009. "The market needs to establish a new bottom before a recovery can take hold," Florance cautioned. "The sooner we reach it, the better off we'll be. If property values need to fall to X, it's better to get there in 18 months not five years." Faced with the grim outlook for 2009, a member of the audience asked Florance if he would advise the broker to give up his real estate practice and work on his golf game for the next 12 months. "Where do you golf?" Florance responded half jokingly before addressing the issue. "We adjust. As we've all seen the industry do in past down cycles, we focus on leasing rather than sales and on property management rather than on new development. And we become advisors. Your clients are going to need your expert advice."
More Distressed PropertiesFrequent readers of CoStar news are probably familiar with our coverage of distressed properties and delinquent loans. In preparation for its first market outlook, CoStar also undertook its first-ever complete analysis of delinquent and distressed properties in the CMBS market. CoStar identified nearly 1,200 commercial real estate loans that were either delinquent in loan repayments or had reached maturity without pay off of the loan. The principal and interest outstanding on those loans as of mid December totaled nearly $8.2 billion. CoStar also compiled a list of nearly 6,100 additional loans that servicers for the various securities have flagged as having potential credit concerns. The current scheduled ending balance of those loans totaled $57.8 billion. In addition, CoStar identified more than 160 properties that had been repossessed by various CMBS trusts. The properties had a loan value at the time they were taken over of more than $1 billion. Based on the properties most recent valuations, the bondholders were likely to take a loss of more than $300 million.
Go GreenNot wishing to end on a dour note, CoStar’s Florance concluded the U.S. portion of the forecast with a look at so-called green properties, which continue to enjoy a premium in the marketplace in terms of higher occupancy levels, rental rates and sale prices compared with "non-green" peer buildings. Currently in the U.S. only 1 in 15,000 properties are LEED or Energy Star certified. In fact, a new federal mandate that is set to go into effect in 2010 is that federal agencies will have to occupy green certified offices. According to Florance, the total federal requirement for green space outstrips the total available supply of green-certified buildings. In analysis of 9.8 billion square feet of office inventory in CoStar’s database, CoStar found that the national occupancy rate of green-certified buildings was 300 to 588 basis points higher than non-certified buildings and commanded rents that were anywhere from $3 to $18 more per square foot per year than the average rent. Green buildings also sold at prices that were up to 64% than the average. Written by Mark Heschmeyer COSTAR

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HBJ Article tells the story NOW!!!

THEN
Date: March 14, 2008
Headline: ‘Downtown office towers jump off starting block in tandem’
THE STORY
Ground-breaking events were held in the spring for three new Class A office buildings proposed for downtown Houston.
All of the events were held within one week by three separate developers. The trio were among a handful of real estate companies that had been mulling over new downtown projects for a year in an effort to meet demand for office space.
Crescent Real Estate Equities LLC, Hines Interests LP and Trammell Crow Co. all announced plans to develop buildings, even though none of them as yet had any tenants.
The three buildings shared another similarity in that the developers all hoped they could obtain LEED Gold certification as sustainable green buildings.
In that busy week for real estate, Dallas-based Trammell Crow and financial partner Principal Real Estate Investors on Feb. 29 started construction of Discovery Tower — a 30-story, 871,000-square-foot office building at 1501 McKinney St. by Discovery Green park.
Houston-based Hines began construction three days later on a 1 million-square-foot office at 811 Main called MainPlace.
The Hines CalPERS Green Development Fund, a Hines venture with the California Public Employees’ Retirement System, is the developer of the 46-story building.
And Crescent held a VIP ground-breaking event on March 6 to launch the proposed 585,000-square-foot 6 Houston Center, which was set to begin construction by May in the block bounded by Rusk, Walker, Caroline and San Jacinto.
NOW
Crescent’s building never got off the ground.
Fort Worth-based Crescent was bought by Morgan Stanley Real Estate in a deal that closed in August — a transaction that changed it from a public company to a private one.
Information about Crescent’s deals became more difficult to obtain after the company was taken private. A Crescent representative was unavailable for comment on the status of 6 Houston Center.
Although Crescent’s building didn’t materialize, the other two projects are moving forward as planned.
Hines announced in May that KPMG LLP would become the building’s first tenant. The company will occupy nearly 109,000 square feet on the top four floors of MainPlace when the new tower is finished in 2011.
KPMG decided to relocate from downtown’s Bank of America Center building, where it now offices, in order to attract future employees with a showcase location.
Trammell Crow has not yet announced a tenant for the 30-story Discovery Tower, but real estate insiders predict that the space will be filled.
New York-based Hess Corp. has been mentioned as a likely candidate for the building.
The energy firm is said to be in the market for 800,000 square feet of space in a downtown building where it would be the sole tenant.
Discovery Tower, which will be finished around the fourth quarter of 2011, is likely to be the only office space that will fill the bill.
Jennifer Dawson HBJ

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or www.edayres.com

BAIL OUT NEEDED?????

The commercial real estate industry is the latest to seek a government bailout.
A dozen real estate development groups have asked Uncle Sam for help to avoid defaults, foreclosures and bankruptcies. The Wall Street Journal reports that some of the country’s biggest developers have asked Treasury Secretary Henry Paulson to be included in a $200 billion loan program recently created by the government to support the market for car loans, student loans and credit card debt.
In a letter to Paulson, the commercial real estate leaders warn that thousands of properties are in danger of foreclosure because current financing is coming due and credit for new financing is hard to come by. The report cites research from Foresight Analytics LCC that says $530 billion of commercial mortgages will be coming due for refinancing in the next three years.
Unlike residential mortgages, commercial mortgages are usually designed to last five to 10 years with balloon payments at the end of the term. A loan must be refinanced or repaid at the end of the term. If refinancing is unavailable, an owner would be faced with attempting a distress sale or losing the property.
Treasury officials have indicated a willingness to consider adding commercial real estate to the $200 billion loan initiative, but it could take time. The program is not even expected to be up and running, let alone modifiable, until February. For more information see www.houstonrealtyadvisors.com or www.houstonrealtyadvisors.net

Aetna Signs 1st Lease at 3 Sugar Creek Center

Aetna, a health care benefits firm, signed a long-term lease for 51,974 square feet of new office space at 3 Sugar Creek Blvd. in Sugar Land, TX. The company will occupy the second and third floors, and is expected to move in the second quarter of next year. The 152,915-square-foot, Class A office building was built last year. The six-story building has three passenger elevators and one freight elevator. There is 100,941 square feet available for lease in the building. For more information see: www.houstonrealtyadvisors.com and www.houstonrealtyadvisors.net

259,000 sq ft Industrial lease

Banta Corp., a subsidiary of Chicago-based RR Donnelley, has renewed its lease for 259,200 square feet within the West by Northwest Business Park, located at 6315 West by Northwest Blvd. in Houston. Micheal Palmer, John Simons and Susana Rosas of CB Richard Ellis’ Houston office represented Banta in the transaction. The landlord, locally based Claymoore Northwest, was represented by Brian Gammil of the Houston office of Transwestern. Terms of the lease were not released. For more information see http://www.houstonrealtyadvisors.com/ or http://www.houstonrealtyadvisors.net/

2009 outlook is stormy Around the World Raindrops Keep Falling

The global economy is sick and the prognosis for 2009 is gloomy at best. The United States and much of the EuroZone are expected to be in a recession next year, while the Asian and Latin American economies will slow significantly, according to global economists. "2009 is going to be a year where we need to wear our hard hats," says Sean O'Dowd, a senior capital markets analyst with Boston-based consulting firm Financial Insights. "We're going to take some artillery fire… it's going to be a nasty fight."
As the financial crisis intensified during the latter part of the third quarter and into the fourth quarter, the availability of credit around the world was severely diminished. This lack of credit has slowed spending in advanced countries and caused foreign investment in poorer nations to dry up. "The countries that have the bigger debt loads are going to get hit harder during this recession," says Thomas Hall, Ph.D. and professor of economics at Miami University in Oxford, Ohio. While economists believe the worst of the financial crisis and capital markets panic has ended, the damage to the global economy has been done. "The word 'credit' is derived from the Latin word meaning trust and people today have a lack of trust that they're going to be paid back," says Ray Torto, global economist with CB Richard Ellis. "It's a huge crisis of confidence, and we have to address that before the economy will improve." The International Monetary Fund (IMF) slashed its 2009 global forecasts in mid-November and now predicts contractions in GDP in the world's most developed economies. The IMF expects the world's largest economy, the U.S., to contract by 0.7 percent in 2009. And, the IMF's new projections for Europe are even gloomier than the European Commission's 0.2 percent growth forecast for 2009. EuroZone growth has been revised downward to -0.5 percent from 0.2 percent. The slowdown in Europe is expected to be widespread, with GDP expected to dip in Germany, France, Italy, and Spain. Across the globe, confidence is severely shaken, and it may never fully recover, experts warn. That means both consumers and businesses are increasingly risk averse and will do all they can to avoid spending money. "Global businesses' sentiment has never been as negative," says Mark Zandi, head economist at Moody's Economy.com, referring to his organization's Survey of Business Confidence. "The financial panic is too much for many businesses to bear." He contends that the "collective psyche of global businesses has been shattered by the ongoing financial panic." The Survey of Business Confidence showed that sentiment fell to another new low during the first week of November. Even worse, sentiment is weak across all industries. Across the globe, business confidence was -22 percent in mid-November. To put that number in context, readings between 25 percent and 30 percent are consistent with an economy that is expanding at potential. Survey readings below 10 percent are consistent with recession. The all-time peak was nearly 40 percent at year-end 2005. "Nearly all respondents think current conditions are eroding and that they will not be any better six months from now," Zandi says. "Pessimism regarding the outlook is overwhelming."Below, the Global Real Estate Monitor tours the globe and provides an economic forecast for 2009.
United States
The U.S. economy has deteriorated significantly under the weight of the financial turmoil, and experts predict that the worst is still ahead. The U.S. economy contracted during the third quarter 2008, and it is expected to shrink in the fourth quarter as well. In 2009, there will be little or no growth, according to experts. "The danger of a severe and protracted recession is high and will be even higher without prompt and forceful action by the federal government," Zandi says. Over the past year, real GDP has increased 0.8 percent, but it declined 0.3 percent in the third quarter, slightly better than the consensus expectation for a 0.5 percent drop but still down from growth of 2.8 percent in the second quarter. The U.S. economy is expected to decline 2.2 percent in the fourth quarter, and Zandi expects no growth in 2009, provided that another $300 billion stimulus package is passed. Otherwise, GDP growth could be negative by as much as 2.5 percent. Meanwhile, experts predict the unemployment rate will continue to rise into 2010, peaking near 8 percent. The most recent numbers from the U.S. Bureau of Labor Statistics show that unemployment was 6.5 percent in September 2008, the 10th straight month of net job losses. Moody's Economy.com forecasts employment to reach its cycle low in the third quarter of 2009, and unemployment to touch its cycle high in the first quarter of 2010.Even worse, consumers are tapped out, says Nathaniel Karp, an economist with Birmingham, Ala.-based Compass Bank. "Consumption is declining at the highest rates in three decades," he notes, adding that consumers are in one of the "worst situations" they've ever been in. While inflation has been a concern over the past 12 months, deflation will be a larger concern in 2009. To date, the U.S. has experienced only two periods of deflation in the past century: a brief and relatively painless episode in 1949 and during the Great Depression from 1929 to 1933. During that four year period, prices in the U.S. fell 23 percent, discouraging spending and investment.
Latin America
While commodity prices and demand for exports to the U.S. are falling, domestic demand throughout Latin America is rising. That means that most countries are facing slower growth and weaker currencies, but will manage to avoid a recession in 2009, experts forecast. Latin America will continue to slow, with regional GDP moderating to 3.4 percent. All Latin American countries will decelerate to 3 percent to 4 percent except Mexico, which will grow by 1.5 percent to 2 percent in 2009. That compares to roughly 2.4 percent this year. Mexico will be the slowest growing Latin American country in the foreseeable future. Mexico's peso has lost 15 percent of its value versus the dollar so far this year, which normally boosts Mexican exports by making them more competitive. Unfortunately, that will not be the case in 2009 since the U.S. and Europe both will have weak demand for imports. In macroeconomic terms, Brazil, Chile and Peru will remain the strongest in the region, while the weakest will be Argentina, Venezuela, and Colombia. Brazil, which has experienced problems with inflation in the past, will benefit from the swift and aggressive action its central bank has taken including rate cuts and the injection of massive liquidity into its banking systems. Argentina's economy remains uncertain, primarily because of issues related to the nationalization of pensions. If nationalization passes the Argentine Senate, then the country could use the $26 billion gained from private pension funds to refinance its debt and avoid default next year. However, in the medium to long run, the nationalization of pensions to pay off immediate debt obligations for 2009 would add to an already-burdensome national debt. For its part, Venezuela's future is also uncertain. The country's political environment is contributing to lack of investor confidence (see how Venezuela's political environment also is impacting its transparency for commercial real estate). Moreover, slumping oil prices are expected to have quite a negative impact on the country, which depends more heavily on oil revenues than does any other country outside the Persian Gulf. According to Moody's Economy.com, more than 90 percent of total export revenues come from oil, while nearly 60 percent of fiscal revenues are tied to this commodity.And, like the U.S. and Europe, Latin America is suffering from the credit crisis. Latin American companies are having a hard time securing short-term lines of credit to finance exports. While central banks around the region have tried to correct the problem, the Latin American equity markets would benefit from a less volatile global credit market.
The U.K. and EuroZone
Uncertainty in the credit markets will "cast a long shadow over Europe," according to Moody's Economy.com. European economies contracted in both the second and third quarters of this year, pushing the region into recession. In mid-November, European finance ministers decided against a EuroZone stimulus package, but its central banks have slashed interest rates. For example, the Bank of England cuts its rate by 150 basis points, and the European Central Bank lowered its rate by 50 basis points to 3.25 percent. The cuts are expected to give a much-needed stimulus to those weakening economies. In 2009, experts predict that United Kingdom interest rates will go as low as 2.5 percent. The U.K. and Germany, the largest economies in Europe, have already experienced significant slowdowns, and Central and Eastern Europe are expected to suffer severe recessions. Like the U.S., the region will undergo substantial economic pain as businesses and consumers continue to deleverage. Moreover, most EuroZone economies will be weighed down by decreased business investment, weak household demand and rising unemployment. The U.K. economy has faltered under the weight of the credit crisis, and like the U.S., it is experiencing its own residential market meltdown. As a result, the British economy contracted in the third quarter.Similarly, Germany, the largest EuroZone economy, has fallen victim to the weakened global climate. Largely dependent on exports to the rest of Europe, Germany has been weakened by both falling domestic and foreign manufacturing orders. However, the German government is working on a targeted stimulus package that is expected to shore up the economy. Unfortunately, a sharp recession in Eastern Europe now seems inevitable since most countries there have been running huge deficits and financing the deficit is almost impossible. That doesn't bode well for the EuroZone as a whole since 30 percent of EuroZone exports are destined for Eastern Europe, more than twice those bound for the U.S. Germany and the Netherlands are the most exposed – their exports to Eastern Europe account for 3.5 percent of their GDP.Moody's Economy.com says several Eastern European and Baltic countries face financial meltdowns akin to Asia in 1997. Across the region, the private sector, including consumers, had borrowed heavily in foreign currency at relatively low interest rates. However, much of the borrowing was short term, and few, if any borrowers hedged against currency fluctuation. Now, foreign currency is unavailable and currency exchange rates are in a freefall. Sadly, these countries have little foreign reserves to back their currencies.In times of stress, emerging economies have historically turned to the IMF, but there are worries that even the IMF might not have the resources to bailout all the countries in trouble. The IMF has approximately $250 billion in reserves – enough to provide 15 or so bailouts similar to the ones it provided for Ukraine ($16.5 billion) and Hungary ($15.7 billion). Moody's Economy.com says EuroZone and Swiss banks are most exposed to the travails of Eastern Europe and other emerging markets. They loaned $3.5 trillion to emerging economies, compared with $500 billion from the U.S. and $200 billion from Japan.
Asia-Pacific
While 2009 is expected to be a tough year for the U.S. and EuroZone, most Asia-Pacific countries will still see positive growth, albeit slower than the past few years. However, some Asian countries including Japan will actually fall into a recession. Unlike the U.S. and the EuroZone, Asia-Pacific's slowdown cannot be blamed on the financial crisis. In fact, most experts agree that the region got off pretty lightly compared to the rest of the world. The bank failures and write-downs that have bedeviled the U.S. and Europe have largely ignored the Asia-Pacific region, despite the large portfolios of U.S. assets that Asia has built in recent years. As of mid-November, Asia has yet to see a bank failure, or a bailout, related to the U.S. credit crisis.Indeed, Asia holds the largest piece of U.S. mortgage-backed securities – roughly $795 billion of mortgage debt consisting almost entirely of securities issued by Fannie Mae and Freddie Mac. But these securities are of high quality and not supported by subprime mortgages. Moreover, Asian investors have not taken a hit because of mark-to-market losses because international accounting rules do not require this type of mark downs for investments expected to be held to maturity.While Asia-Pacific is largely unscathed from the mortgage meltdown, the credit crisis has taken a bite out of the region's export activity. That's a big problem because exports make up a higher share of the region's GDP than in any other region in the world, according to Moody's Economy.com. Any decrease in overseas demand will have a marked impact on the region's economic growth (see related story on U.S. seaport activity). China, which has become the world's manufacturing center for everything from shoes to soap, has already seen its exports decline precipitously as demand from the U.S. and Europe withers. The country expects to post growth of around 9 percent over the next few years compared with 11.9 percent in 2007. Interestingly, anything below 8 percent GDP growth in China is considered a recession by the Chinese government. The rest of the Asia-Pacific region will likely follow China's lead, and countries that have come to rely on China to drive their economies will also see their growth rates decline. That means the next 12 months will be the toughest the region has seen in years, with growth at 10-year lows.However, the slowdown can be mitigated by government action. "In India and China, the government controls the major financial institutions," Zandi says. "It can keep the wheels of the real economy greased by simply ordering state-owned banks to provide liquidity to targeted markets."China, for example, recently unveiled a massive fiscal stimulus package, pledging spending of 4 trillion yuan through 2010. The government will focus on 10 major areas: affordable housing; rural infrastructure; expansion of transport networks; improvement in health and education systems; environmental protection; industrial innovation; post-earthquake reconstruction; raising average income; reform of value-added tax; and strengthening the role of the financial industry. The stimulus package is expected to help the entire Asia-Pacific region. Unfortunately, it won't help the regions that are really suffering, specifically the U.S., says Richard Green, Ph.D. and director of University of Southern California's Lusk Center for Real Estate. "There's no real chance that strength in other parts of the world will boost the U.S.," he says. "We forget that China, as massive as it is, is still much smaller than the U.S. economy. We're going to have to pull ourselves out of this." For more information see: www.houstonrealtyadvisors.com or www.houstonrealtyadvisors.net

BIOFUELS POWER CORP. TO PURCHASE POWER PLANT

The Woodlands, Texas-based Biofuels Power Corp. has agreed to purchase the decommissioned H.O. Clarke Electric Generating Station, located at the intersection of Main Street and Hiram Clarke Road in Houston. The acquisition will include the 79-acre site, as well as all of the remaining infrastructure and equipment, which includes 65,000 barrels of aboveground storage tanks and a high-pressure natural gas pipeline that is connected to the distribution system. The power station, which was constructed in the 1940s, was decommissioned in 2004. At the time, the station’s gas-fired turbines were also removed. Biofuels Power Corp. plans to redevelop the site into a clean energy industrial park that will provide power to tenants by way of biofuels, biomass, natural gas, biogas and solar energy. The deal is expected to close by the end of the year. The construction timetable for the redevelopment was not disclosed. For more information see: www.houstonrealtyadvisors.com or www.houstonrealtyadvisors.net