Commercial Real Estate Frontline

For a short time it was easy to dismiss the problems in housing as just that, problems in housing, but it’s now crystal clear that the housing disaster is taking a deep bite out of commercial real estate values. With new Case Shiller home sales data posted just yesterday I thought it appropriate to to make a quick examination of what was reported and what it means to your commercial real estate.

The Report

Case Shiller found that home prices declined by 18.2% year-to-year in the 20 regions it has tracked since 1987. The WSJ reports

Joshua Shapiro, chief U.S. economist at forecasting firm MFR Inc. in New York, noted that home prices rose some 155% from 1999 to their peak and have so far reversed only a fraction of that amount. He estimates the index “is perhaps one-half to two-thirds of the way through its ultimate total decline in this cycle.”

So home values are off by a lot and they’re going to get worse, perhaps doubling the loss suffered so far before they get better. What then for commercial real estate?

The Affect of Home Prices On Commercial Real Estate

Do you have a home equity line? If you do, what have you used it for? Many Americans used their home equity lines not just for home improvement and the occasional luxury item, they used it to live in a style that they had become accustomed to… but could no longer really afford.

Ours is a consumer driven economy. The more we spend the better we do over all. But what happens when we’re not spending our own money? Our economy benefited from a false prosperity because the fact is that real incomes didn’t budge. Growth was fueled by cheap debt. Now that the underlying assets that supported that debt are significantly devalued growth has ceased. The absence of spending negatively impacts retail, manufacturing, and so on up the line through our entire supply chain of goods and services. Here’s the big problem, these are your tenants.

Hopefully if you own or plan to own commercial real estate you are acutely aware of the fact that the value of your commercial property is inextricably linked to the value and quality of your leases. As business suffer they will contract; they will use less space, they will work with fewer employees, they will consume less, and if they survive they will look to save wherever they can including in the rent that they pay.

Beyond the simple equation I’ve laid out above is the fact that our complex financial system is constructed around a web of securitized assets and leverage and hedges, the basis of which is largely anchored in the American home. The devaluation in housing is impacting lenders such that they are significantly less liquid and abundantly more cautious than they have been. The net effect is that they may have been willing to take a risk on an asset or a borrower in the past comforted in the knowledge that appreciation would cure any defects in underwriting and now that comfort is gone.

In economic episodes past it was not always the case that a simple dip in home values in one region or another would impact commercial real estate values, but this is different, the boom and bust began in housing.

January is a great time to evaluate your position in the market and set your goals for the year and beyond. If you’ve been hoping for a quick turnaround in commercial real estate values or you’ve been considering taking some sort of action with regards to financing, or disposition, or simply fortifying your balance sheet against the storm there is no time like the present.
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  January 09 Case Shiller Raw Data (63.5 KiB, 3 hits)
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