Commercial Markets Stabilizing, Demand Growing…

Lately, there have been signs indicating the U.S. commercial real estate sector may have begun a slow recovery. While the recovery of this sector is expected to take a long time in Europe due to the financial crises of many of its member countries, the U.S. market is looking optimistic for various reasons.

In its recently released Commercial Real Estate Report, Credit Suisse’s Customized Funds Investments Group (CFIG) states that “while sovereign debt concerns could delay the commercial real estate sector’s recovery in Europe, The U.S. market may be less risky since the U.S. economic recovery is expected to be more pronounced and more likely to occur before most other developed economy turnarounds.”

The authors of the report say U.S. investors will be able to capitalize on the situation by “acquiring distressed property; investing in income-generating, value-added real estate such as multifamily and office properties; and concentrating on private real estate investments.” Opportunities include self-storage, medical offices, student housing and senior housing. The authors also noted that the “road to complete recovery still appears somewhat volatile.”

Furthermore, the report highlighted several critical factors that are required for a sustainable in commercial real estate. These include increase in property demand, sustained growth in U.S. economy, improved valuation of commercial properties, stabilization of bond and credit markets, resurgence of commercial mortgage-backed securities (CMBS), and significant improvements in access to credit.

According to the National Association of Realtors (NAR), the improving economy and job creation mean growing demand for commercial real estate. NAR’s forecast of vacancy rates for the second quarter of 2012 and beyond include a decline of one percent in the office sector, 0.9 percent in industrial real estate, 0.5 percent in the retail sector and 1.1 percent in the multifamily rental market.

The Society of Industrial and Office Realtors’ (SOIR) Commercial Real Estate Index, which is an attitudinal survey of more than 360 local market experts, showed a solidification of market basics. The SOIR Index which measures the impact of ten variables rose 6.8 percent to 57.5 percent in the first quarter, the highest since the fall of 2008.These numbers were generally driven by improved market conditions in the South and Northeast. Although the index is much lower than 100, which is the level representing a balanced marketplace, this is the sixth consecutive quarterly improvement after almost three years of decline. The index hasn’t reached the 100 level since the third quarter of 2007.

Vacancy rates in the office sector are expected to fall from 16.3 percent in the second quarter of 2011 to 15.3 percent in the second quarter of 2012. At slightly under 9 percent, Honolulu and New York City currently have the lowest office vacancy rates. Office rents are projected to rise 0.3 percent this year and an additional 4.3 percent in 2012.

Industrial vacancy rates are expected to go down from 13.9 percent in the second quarter to 13 percent in the second quarter of 2012. Los Angeles and Salt Lake City have the lowest industrial vacancy rates, which is in the 7-8 percent range. The annual industrial rent is expected to decline 1.5 percent in 2011 before rising 2 percent next year.

Multifamily housing (apartment rental market) vacancy should drop from 5.8 percent in the current quarter to 4.7 percent in the second quarter of 2012. With vacancies below 3 percent, Pittsburgh, San Jose and Portland, Oregon have the lowest multifamily vacancy rates as present. The average apartment rent is likely to rise 3.4 percent this year and another 4.3 percent in 2012.

Retail vacancy rates are expected to decline 13.1 percent in the second quarter of this year to 12.6 percent in the second quarter of 2012. Honolulu, Long Island, NY, and San Jose have the lowest retail vacancy rates at slightly below 9 percent. Average retail rent is expected to decline 1.4 percent in 2011, and then rise 0.7 percent next year.

Foreclosures to Eclipse 2 Million This Year

In case you missed the news the other day, Nobel Prize-winning economist Joseph Stiglitz dropped another bombshell on the nation’s real estate industry. He expects an additional 2 million foreclosures to hit the U.S. this year – adding to the whopping 7 million that have occurred since the economic crisis of 2008.

            “U.S Foreclosures are continuing apace,” Stiglitz told a packed news conference near Port Louis, the capital of Mauritius. “A quarter of U.S. homes are underwater.”

            Why the gloomy forecast? Because the number of U.S. homes worth less than their outstanding mortgage jumped in the fourth quarter as prices dipped and lenders seized fewer properties from delinquent borrowers.

            Currently 15.7 million homeowners had negative equity, also known as being underwater, at the end of 2010, according to Seattle-based Zillow Inc. That’s a 13 percent increase over the 13.9 million in the previous three months.

            That total represented 27 percent of the mortgaged single-family homes, the highest in Zillow data dating back to the first quarter of 2009.

            The news on the local front appears just as bleak.  The Orlando Sentinel reported in its February 12th edition that the number of foreclosed homes on, or about to hit Metro Orlando’s resale market has more than doubled in the past year – forcing down the prices of other houses that have already lost more than half of their value since before the recession.

            The four-county metro area of Orange, Seminole, Osceola and Lake counties had 13,712 bank-owned properties in January – up from 5,874 a year earlier, according to figures from California-based RealtyTrac. This has contributed to a record statewide glut of foreclosed properties that now stands at 104,759 and counting.

            “Americans today are worse off than they were 10 to 12 years ago,” Stiglitz said, adding that the U.S. faces “increasing inequality,” with the “upper 1 percent controlling 40 percent of wealth. Instead of trickling down, it has trickled up.”

            There are, however, some significant positives that have come to light.

First, foreclosures did slow down in the fourth quarter. Lenders, including Bank of America Corp. and Ally Financial Inc., halted many home seizures after accusations they used improper documentation and processes. Attorney generals in all 50 states are investigating.

But, more importantly, the wave of foreclosures, especially here in Central Florida, has created a tidal wave of opportunities for both homebuyers and investors alike.

Prospective buyers who previously were priced out of the housing market are using this opportunity and taking advantage of lower property values to purchase their first home and begin a new chapter toward their futures. Lower property values also have been a boon to investors who are adding to their real estate portfolios.

Take Larry and Janelda Minor, for example. They purchased a vacant eight-unit apartment complex in Kissimmee valued at $350K for just $200K. Within a few months all eight units were fully rented – a property lemon was turned into lemonade.

“Our experience with Rajia Ackley with Coldwell Banker Ackley Realty while purchasing the property was very positive,” the Minors said. “Our questions and concerns were answered quickly and completely throughout the entire process. We appreciate her guidance in helping us secure this commercial property during these trying times.”

Despite the gloomy real estate predictions of Joseph Stiglitz, et al, there’s still some happiness to be found. Just ask the Minors.

            We’ll keep you updated.

Fewer Workers, Higher Commercial Vacancies

The demand and supply cycle of commercial real estate properties is not dependent on the national GDP, but it is directly proportional to the U.S. job market. “Absorption” is the key word in commercial real estate. Companies hire and fire based on corporate profits. In a free-market capitalistic system more workers are hired during good economic times, which means more office space is required (and absorbed). Conversely, employers issue pink slips when profits decline which creates a greater supply of commercial space.

In recent times, the commercial real estate industry peaked in 2007, which corresponded with the peak of corporate profits in 2006. At its lowest point in mid-2009, commercial property prices slid an average of 51% from their 2007 peak. In the last three months of 2010 this segment caught everyone off-guard by making a surprising and unexpected come back. In some areas, prices have rebound 33% and are off by about 18% from the peak.

Although prices are up in some markets, rents are sluggish and lag the rate of price increase in most U.S. commercial real estate markets. Experts are concerned about this lethal combination of low rents and high prices because of the threat of rising interest rates. It is unlikely that the interest will fall further. This means unless the rents catch up with rising prices, any small increase in the interest rate would take the air away from this short commercial rally.

The sudden rise in prices and the demand for commercial space is attributed to the massive spending and expansion of the federal government. This perhaps explains why commercial real estate prices have skyrocketed in metro areas such as Washington, D.C. and Manhattan, which are the biggest beneficiaries of the federal largesse. In most other areas of the country, prices continue to be sluggish and supply remains high, which reflects the levels of employment or lack thereof in the region.

While “jobless economic recovery” has become an overused buzz word at water cooler conversations and in the blogosphere, commercial property owners are fully aware that sustained job creation is the only way to decrease vacancies and increase absorption, rents and property values. However, economic data provided by various agencies continue to paint a bleak picture about job growth, at least in the short term.

Financing Guidelines for Commercial Properties

Although there are similarities between residential and commercial mortgage, there are specific guidelines and rules that apply for financing commercial properties, which comprise structures such as office buildings, apartment complexes, healthcare facilities and retail outlets. Commercial financing typically involves a lot more paperwork.

While an individual borrower’s credit rating is the primary qualifying factor for residential home financing, commercial mortgages are in most cases underwritten based entirely on the attributes of the property being mortgaged. Since commercial mortgages are typically assumed by businesses instead of individual borrowers, lenders not only require the business to be stable and creditworthy, but they also require the individuals that own the business to have positive personal credit ratings.

Besides checking credit ratings, underwriters also look at the location of the business being purchases, past income generated, as well as projected income. The commercial mortgage terms also depend on the type of business the borrower is involved in and the type of premises or facility that the borrower wants to purchase. The first step in underwriting a commercial property is to calculate the property’s cash flow, which is commonly referred to as net operating income, or NOI.

Debt coverage ratio or DCR, which is defined as the monthly debt compared to the net monthly income of the investment property in question is one of the key components in the loan evaluation process. Lenders typically seek a minimum debt service coverage ratio which ranges from 1.1 to 1.4, which is a net cash flow ratio of the income the property produces and the debt service or mortgage payment. Lenders also consider Loan to Value or LTV. LTV is the amount of a mortgage as a percentage of the total appraised value. Commercial mortgage LTVs are usually between 55% and 70%, unlike residential mortgages which are typically 80%.

The most common commercial mortgage is a fixed-rate loan, where the interest rate remains constant throughout the term. In residential mortgages, the word “term” indicates the time period of the loan during which the interest rate is fixed, as in a 15-year or 30-year term. On the other hand, most commercial loans require a total payoff, known as a balloon payment, after a certain time frame. The length of time allowed between the amortization and the balloon payment is known as the term. For example, if a loan had a 30-year amortization schedule, with a 10-year term, it would be referred to as a 10-year balloon with a 30-year payment schedule.

Unlike residential mortgages, commercial financing often includes a prepayment penalty. This is done because lenders make their money on the interest that is paid throughout the life of the loan and prepayment can cut short their profits. However, in today’s competitive commercial loan market, borrowers can negotiate for the elimination of the prepayment clause.

Commercial Real Estate Market Stabilizing?

For the past several years, commercial real estate had been billed as the next big train wreck. Recently however, many investors have been shouting all aboard! Let’s see why.

The U.S. commercial real estate market ended on a high note in 2010, following blockbuster transactions in December. The sales figure for 2009 was $54.6 billion. In 2010, it increased to $115 billion, a mammoth 109% increase. Over $21 billion worth of transactions took place in December, which was the highest sum for a single month’s trading since the end of 2007. The fourth quarter sales of about $46 billion was comparable to the quarterly sales volume of 2004, which was considered a healthy recovery year.

Almost everyone in this industry was caught off guard by the sudden increase in transaction activity in 2010. Most of this recovery is centered on core assets in primary markets.  Analysts expect to see an increase in activity in secondary markets in 2011.

The apartment market seems to have made a clear shift to recovery mode since the beginning of 2010. The apartment vacancy rate was 7.1% in the third quarter of 2010, down from 8% at its peak in the fourth quarter of 2009. Other areas of the commercial property segments have also shown slight improvements. The national office space vacancy rate was 17.8% at the end of 2010, down by 10 basis points from the 17.9% peak it reached in the second quarter of that year. Commercial property investors are encouraged by the overall trend, and they anticipate a recovery in the leasing markets as well.

No one can guarantee that the commercial real estate recovery train won’t jump the track. There are many hills and valleys it must negotiate such as the rising number of shaky mortgages, weak household balance sheets, slow employment recovery, the recent back-up in bond yields, lack of corporate pricing power and poor fiscal outlooks at all levels of government.

Despite these hurdles and headwinds, some industry experts predict commercial sales to surpass $200 billion in 2011. There are plenty of factors to support such claims including the anticipated higher sales volume in the secondary markets, and an abundance of investor types – foreign investors, corporations, REITs, pension funds and private investors, who have all been waiting for the right time…and 2011 may just be their opportune time period.

Coming Soon

In the near future this blog will be full of information on Real Estate in Central Florida.  Information will be both for buyers and sellers. 

In the meantime, please visit our website, facebook and join our email list using the links.  Everything is under construction, so so watch us grow!

Foreign Investors Rank U.S. No. 1 Commercial Market

The U.S. commercial real estate market is ranked the No. 1 choice for investment this year and viewed as the best opportunity for price appreciation, according to a survey of foreign investors by the Association of Foreign Investors in Real Estate (AFIRE).

More than 60% of respondents indicated that the U.S. offers the best potential for capital appreciation. This number is a dramatic reversal from 2006 when it reached a lowest level of 23%. The next-ranked country, China, was 54 percentage points behind the U.S.

“As the fear of a double-dip recession has faded, investors are becoming more enthusiastic about the prospects for the U.S. economy and are taking aim at real estate investment opportunities in the U.S.,” said James Fetgatter, AFIRE chief executive.

The survey respondents represent more than US$627 billion in real estate globally, including US$265 billion in the United States, and 72% of them say they plan to invest more capital in the U.S. in 2011 than they did in 2010.

Most Popular Cities

Properties in stronger markets are attracting investor interest, while smaller properties in slower markets continue to display signs of distress. According to the AFIRE survey, investors overwhelmingly chose New York and Washington, D.C. as the two top global cities for their real estate investment dollars.

“Except for multi-family housing, [investors] are not scattering their interest throughout the U.S., but rather narrowly targeting it to New York City and Washington, D.C., to an even greater extent than before,” Fetgatter said.

For the full AFIRE survey report, visit http://www.afire.org/.