In a sign that the country’s commercial real-estate market is finally turning the corner, new statistics show that office rents that have been falling throughout the economic downturn are beginning to stabilize.
The industry’s recovery is likely to be a slow one. Many businesses are continuing to give up office space as new hiring stays sluggish, the timing of the economy’s recovery remains uncertain and companies figure out how to fit more workers into less space.
Investors are taking action. In the latest deal, publicly traded landlord Boston Properties Inc., run by real-estate and media mogul Mortimer Zuckerman, on Monday said it would buy Boston’s tallest skyscraper, the John Hancock Tower, for $930 million.
Commercial real estate, an enormous sector with some $1.4 trillion of debt coming due by the end of 2014, has been closely watched by regulators and financial companies because it could act as an anchor on the economy as it struggles to recover. For months the news has been bad, with declining rents and rising vacancies pushing more properties into default, foreclosure and bankruptcy. Thousands of landlords are struggling with properties valued at less than their mortgages, like millions of “underwater” homeowners.
The pressure on rents now seems to be easing. Average effective rents—taking into account concessions such as a few months of free rent—for some 4 billion square feet of office space tracked by research firm Reis Inc. fell by just a penny in the last three months, the smallest quarterly decline since 2008. At $22.05 per square foot per year, effective rents are 12% below the 2008 high of $25.07.
There is new data indicating that the hard-hit commercial office market is showing signs of stabilizing.
In some cities, the improvement has been much better. In New York, for example, where rents plummeted 19% in 2009, they were up 0.2% to $43.75, in the most recent quarter, according to Reis. Washington, D.C., remains the nation’s healthiest office market, with a vacancy rate of 9.8%. One of the biggest leases of the quarter: the Securities and Exchange Commission’s deal to occupy 900,000 square feet of space just south of the National Mall at a starting rate of $44.80 per square foot.
Rents continue to fall in many areas hit hard by the housing bust, including Phoenix, Las Vegas and San Diego.
In another sign that the bottom is near, the increase in the national vacancy rate in each of the past two quarters was smaller than quarterly changes throughout 2009. Reis economists said the vacancy rate is now unlikely to reach the 1992 high of 18.7%. At the time, the commercial-real-estate industry was reeling from massive oversupply. “If we’re not at the stabilization point, we’re getting close,” Reis economist Ryan Severino said.
With rents stabilizing, investors have started to become more active in buying property, such as the Hancock tower, which creditors bought out of foreclosure and then sold to Boston Properties. The purchase price of that property is still far off the roughly $1.3 billion for which it sold during the boom. But in prime markets like Boston, prices have bounced back from their lows of the recession.
“The best buildings not only do well when everybody does well, but they do relatively better when everybody doesn’t do well,” said Mr. Zuckerman, the Boston Properties chief executive, in an interview. “Rents have gone down across the board, but that inspires a lot of companies to go into the best buildings, which they now feel they can afford.”
All told, office buildings in 79 metropolitan areas tracked by Reis lost 1.9 million square feet of occupied space in the third quarter, pushing the national office vacancy rate to 17.5%, the highest level since 1993.
The turmoil hitting commercial real estate is the worst since the early 1990s, when the sector helped drag the economy into recession largely due to overbuilding. This time around, the problem is demand. Millions of job losses have eliminated the need for hundreds of millions of square feet of office space.
In addition to the 135 million square feet of space that businesses have already given up, many offices around the country are filled with the vacant desks of laid-off workers. That means that even when companies start hiring again, they won’t need more office space right away.
Another factor in what’s likely to be a slow recovery: changes in workplace design that require far fewer square feet of office space per employee.
In San Francisco, for example, accounting giant Deloitte recently inked a deal that reduces the square footage of its San Francisco headquarters by about 40%, even though the company plans to expand its head count in the city by 10% over the next year.
The commercial real estate sector includes roughly $6 trillion worth of office buildings, stores, hotels, rental apartments and other properties. Other property types besides office also have shown signs of stability in recent months, thanks to such things as increasing business travel and growing demand for apartments. Retail sales are slowly rising, which means malls could recover as retailers’ renewed leases reflect higher sales and retailers begin opening additional stores. But mall vacancies, as of the second quarter, were at their highest point—9%—in the 10 years that Reis has tracked the figures.
There’s much pain still to come. A mountain of commercial real estate debt sliced and diced on Wall Street during the boom is scheduled to come due in the coming years. The delinquency rate for those commercial-mortgage-backed securities topped 9% for the first time last week, research firm Trepp LLC said.
The lodging sector is the hardest hit, with a delinquency rate of 19.3%. Industrial property, which is benefiting from the pickup in global trade, has the lowest delinquency rate, 6.5%.
Several metropolitan areas in the nation’s midsection continued to be pummeled by weakening demand for space. Chattanooga, Tenn.; Dayton, Ohio; and Tulsa, Okla., all saw vacancy-rate increases of one percentage point or more in the third quarter. (credit a. troianovski wsj)