Commercial real estate rebound lags behind other indicators

It isn't clear if Wynonna Judd was singing about commercial real estate in her hit "Rock Bottom" from a few years back.

But the lyrics "rock bottom is good solid ground" most certainly applies to the industry to day.

The economy seems to be bumping along at what many are calling the bottom, where the lack of more negative news is good news, and a few bright notes give hope there is light at the end of the tunnel.

Consumer confidence rebounded in April to where it was in September, and the pace of job losses has abated somewhat. Positive news has also helped propel the stock market over the last eight weeks, and the S&P 500 is up nicely since its March 9 low.

In the commercial real estate world, however, consumer confidence and the stock market surge don't translate to transactions and development.

In fact, it feels more analogous to going outside after a heavy downpour where the river has flooded and everyone is trying to figure out how high the crest will be.

So while the leading indicators say perhaps it is time to come out of our bunkers, those who watch commercial real estate, as a lagging indicator, are trying to measure how high vacancies and cap rates are going to go.

This downturn has been somewhat indiscriminate, causing job losses across a broad swath of the economy. Employment is still negative in some 90 percent of the nation's top markets.

And with that, office and apartment vacancies have increased rather dramatically in the past few months.

Only three markets in the top 60 had apartment vacancy rates below 5 percent at the end of the first quarter of 2009, compared with 21 markets at the same time last year, according to Torto Wheaton, a research firm owned by real estate brokerage CB Richard Ellis.

The Richmond area's overall apartment vacancy rate was 7.7 percent at the end of the first quarter, up from 3.1 percent during the same time a year ago, the Torto Wheaton research showed.

Reis Inc., the New York-based commercial real estate market research firm, found 72 markets in the top 80 markets having vacancy rates greater than 12 percent at the end of the first quarter compared with 55 markets a year ago.

The Richmond area's office vacancy stood at 13.4 percent in late March, up from 10.3 percent in 2008, according to Reis.

These statistics will continue to get worse even as the economic downturn slows because slower employment loss still means there are fewer people to fill office space and apartments.

The good news is that the sooner real estate investors and lenders feel as if they've found the good solid ground of rock bottom, the faster the industry can start to recover.

Defining the bottom can provide clarity, an important ingredient in deal flow.

The lack of clarity in the markets today continues to be most evident in the weak volume of investment sales.

According to data from Real Capital Analytics, sales of apartment properties in the first quarter of 2009 fell 86 percent compared with the first quarter of 2008. That happened despite cheap and available debt from agency lenders, Freddie Mac and Fannie Mae.

Outside of Freddie and Fannie, debt is more expensive and scarce.

Rates for five-year and 10-year loans are up slightly and now range from a low of 6.75 percent to a high of 8 percent for most property types, according to the John B. Levy & Co. National Mortgage Survey.

As most lenders continue to be over-weighted in real estate loans, they remain extremely choosy about deals they lend on.

Despite the slowdown nationally, several apartment properties traded in the Richmond area at very aggressive amounts per unit.

Two Virginia Commonwealth University student apartment deals - RAMZ Hall and Capital Garage, both on West Broad Street - traded for an average price per unit that was in excess of $160,000.

The 120 units had been bought in January 2006 by ING Clarion. The deal fetched $19.3 million, which was slightly lower than the $21.7 million ING paid three years ago.

Interestingly, ING had valued the properties at $24 million in a December 2007 report and portfolio review, so the sales price was 20 percent off its internal valuation at that time.