Experts: Greatest Challenges Still Ahead

NEW YORK CITY-There may be some differences of opinion as to exactly when the world changed for commercial real estate. Bob Bach, SVP and chief economist at Grubb & Ellis, says it happened on Sept. 7, the day that Fannie Mae and Freddie Mac went into federal receivership. William Collins, senior managing director at Cassidy & Pinkard Colliers, says the onset of the current dramatic slowdown post-dates the collapse of Lehman Brothers and began about four weeks ago. However, neither would dispute that the greatest challenges of the current market–and the greatest opportunities for those in a position to take them–are still ahead.

“2008 has been a tough year,” Collins said Tuesday at a press briefing here sponsored by the four Colliers entities that merged into a new holding company in August. “2009 will be tougher.” Sales prices in the New York area will decline anywhere from 25% in the city to 40% in the suburbs before all is said and done.

Speaking at a similar briefing his firm sponsored on Wednesday, Bach said vacancy across the commercial sectors will peak in early 2010, about the same time that rents reach their trough. Volume in the New York City metro investment sales market, which Real Capital Analytics says had already declined 64% across the asset classes for the first three quarters of ‘08, will improve in ‘09–but that will be due to a flood of distressed properties hitting the market.

Despite the steep drop-off in sales volume, both Collins and Glen Esnard, president of Grubb & Ellis’ capital markets division, noted that average asset prices have not yet declined appreciably. One reason is that many of the properties that have moved in ’08 have been trophy assets on the order of the Macklowe Properties portfolio. It will take the sales climate of the next year or two, when owners may no longer have the option of selling only class A properties, to show where pricing actually is, Esnard said.

Meanwhile, values have eroded. Collins said they’ve slipped anywhere from 15% to 30% in the past 30 days, while Esnard compared pricing erosion to a black hole. “You can’t see it, but you know it’s out there and it’s very big,” he said. That lack of clarity in pricing has extended to cap rates–up about 33 basis points, far below the rise to a historic average of 9% predicted recently by Goldman Sachs, Esnard said.

He noted that $33 billion of CMBS will roll in 2009, and the rollover rate will rise to $55 billion per year by 2012. A lot of that cannot be refinanced at the current rate. Webb pointed out that CMBS issuance has fallen off a cliff, dropping from $230.2 billion in 2007 to $12.1 billion YTD. Nor has there been a vehicle to replace CMBS, although experts from both companies predicted there will be one eventually, probably in a different form.

However, speakers at both briefings offered reasons to be optimistic. David Arena, president of Grubb & Ellis’ New York region, subtitled his PowerPoint presentation “It’s Not the Apocalypse.” By comparison to the 1969 through 1974 and 1987 through 1993 down cycles–which Arena sees as most similar to the current one–this downturn will be shorter-lived, Arena said. The reason is a lack of overbuilding.

And while Bach noted that office as well as retail will see upturns in vacancy, Grubb’s managing director of healthcare properties, Danny Prosky, offered medical office space as a bright spot. Nationally, sales transactions of medical office properties have declined, although not as severely as in other sectors. The leasing market, though, is another matter: there’s little vacancy and relatively little opportunity to convert other office space to medical use, due to the expense involved.

Distressed sales will also present opportunities to opportunistic investors. Webb noted that Colliers officially launched its distressed assets group a month ago, and has already taken on six million square feet of distressed office and industrial assets in the Southeast and Midwest. Property sectors in the Northeast tend to be more resilient, and Colliers therefore expects to see fewer distressed assets go on the market in this region.