CRE Sector Still Suffers Despite Economic Decline Slowdown

Jamie Woodwell, MBA’s vice president of commercial research who oversees the study, said what’s happening is “a severe recession, which has a clear impact on commercial real estate. A decrease in GDP and job losses lead to a decrease in demand for the commercial real estate base.”

The real gross domestic product shrank at a 5.7% rate in the first quarter, and the job rate is still declining, with 345,000 jobs down in May.

However, despite the persistence of the economic downturn, its pace is easing.

The GDP shrank at a 6.1% annual rate in the previous fourth quarter, and the second and third quarters are expected to see more modest declines, with the rate of production falling under 2% over the course of the year, according to the quarterly report.

Even though May saw a decline of 345,000 jobs, February, March and April saw 504,000, 652,000 and 681,000 respectively, according to the Bureau of Labor Statistics.

The numbers represent a smoothed series and are seasonally-adjusted. Unadjusted numbers showed that in April and May, the economy actually added 271,000 and 319,000 jobs, respectively. This is despite the adjusted numbers reporting a decline.

Goods-producing jobs have taken a significantly greater share of the job losses compared with services-producing occupations, declining 12% versus 2.4% over the last year. Yet, the services employment declines are the most severe drops on a percentage basis.

The economic downturn is also having a direct effect on property operations. At the core of the problem is much more space being put back into the market through decreased demand than coming back in through new construction.

All property types are feeling the pressure of the recession, whereby 64 million square feet of excess space exists for the apartment market, 38 million for the industrial market, 45 million to the office market and 101 million to the retail market.

Asking rents are down and vacancy rates are up. Office, retail, apartment, industrial and all other property types have seen vacancy rates climb. Retail properties have been most affected, with vacancy rates climbing 16.2% from 11.3% a year earlier.

First quarter property sales totaled only $8.9 billion, 80% down from last year’s $43.3 billion, and significantly down from $125.5 billion 1Q07.

Cap rates have been trending up and while prices were going down. In the first quarter, they averaged 7.4% and were 10% higher than during 1Q07.Commercial property prices fell an average of 5.8% to 7.7% this quarter, depending on the index used.

As a result, average commercial property prices at the end of this quarter were down between 23% to 26% from their peak in 2007.

Originations have also been hard hit, with first quarter commercial and multifamily mortgage originations 70% lower than 1Q08, at which point they were 53% lower than the previous year.

The CMBS market saw the greatest decline, at negative 96%, followed by commercial banks at negative 80%, life insurance companies at negative 66% and Fannie Mae and Freddie Mac at negative 26%.

Echoing the trend of a commercial real estate downturn, Woodwell said transaction activity was slow. “They were generally very low in the first quarter, but were declining more quickly in the fourth quarter,” he said.

Though the pace transaction is hurting, there was moderation during the first quarter. Originations fell 26 percent from 4Q08 to this quarter, after falling by 65% between the third and fourth quarters of 2008.

The level of mortgage debt outstanding has remained relatively stable — between 4Q08 and this quarter it dropped $33 million on a $3.5 trillion base.

This relative stability is made possible by the longer term nature of commercial and multifamily mortgages compared with other types of financing, such as commercial paper, corporate loans, credit cards and others, where changes are more abrupt.

In this first quarter, banks, thrift and the GSEs, including Fannie Mae and Freddie Mac, increased their holdings of commercial and multifamily mortgages. Meanwhile, more loans were paying down and paying off in new mortgage originations in the CMBS market and life insurance companies.

Commercial and multifamily mortgage delinquency rates are under pressure as well, where delinquency rates for many investor groups this quarter rose to levels higher than those seen during the 2001 recession.

Rates for every investor group appear to remain well below the levels of the real estate recession of the late-1980s and early 1990s.