Businesses Vacate at Fastest Pace in Years, Pressuring Landlords and Their LendersBusinesses are dumping office space at the fastest pace since the months after the Sept. 11 attacks, increasing the financial stress on commercial-real-estate owners and their lenders, many of them already ailing financial institutions.
Nationwide, rents on office properties -- including landlord concessions and discounts -- were flat in the third quarter, the worst result for office-property owners since late 2004 -- when commercial real estate began to emerge from a prolonged slump, according to Reis Inc., a New York real-estate research firm.
Rent stagnation and increasing vacancies put "strain on borrowers to make payments on mortgages," said Sam Chandan, Reis's chief economist. "It hasn't shown up yet in terms of delinquency rates, but this is clearly an issue we need to be very attentive to," he said. Almost every type of financial institution, from community banks to Wall Street, lends to office-building owners.
The office market in suburban areas and smaller cities has been declining throughout the year. But now, with a recession looking inevitable, the pain is spreading to most large metropolitan areas. Previously immune cities such as San Francisco and Boston saw vacancy-rate increases in the third quarter. San Francisco's vacancy rate rose 0.6 percentage point to 9.9% in the quarter. Boston's rate rose 0.8 percentage point to 11.7%.
Of the 79 markets Reis tracks, vacancy rates increased in 66. Rents declined or were flat in 40.
For the third quarter in a row, businesses vacated more space than they took nationwide, a phenomenon known as negative absorption. About 18 million square feet of space were emptied, the most since the first quarter of 2002, when 23 million square feet were vacated. With the addition of 11.5 million square feet of new space, the nation's office vacancy rate rose 0.5 percentage point to 13.6%, the biggest increase since the months following 9/11.
Commercial real estate so far has fared much better than residential. Cash flows of most properties have stayed healthy and delinquency rates on commercial mortgages have remained low. Unlike the real-estate collapse of the early 1990s, the market also hasn't suffered from overdevelopment.
But the office sector has been suffering declining values from the shortage of financing. Now the problems are beginning to be compounded by declining rent, rising vacancies and mounting expenses for attracting and retaining tenants. This will add to the strain on financial institutions that already have been stuck with tens of billions of dollars of commercial-real-estate debt and securities. Many of them may choose to sell this troubled debt to the government if Congress passes the proposed bailout legislation.
Because real estate moves slowly, the financial turmoil of the past few weeks hasn't yet showed up in the numbers. Mr. Chandan predicted the bank failures and consolidations will be reflected in office space later this year and in 2009.
Even so, the once-strong New York City market is showing signs of cracking. Its vacancy rate rose 0.4 percentage point to 6.1%, still the lowest in the nation. But property owners are already sensing the downturn.
Douglas Durst, a major New York City office-building developer who owns more than 8.5 million square feet of office space, said tenants are pulling back from leasing deals. For example, one of his tenants just backed out of a plan to move from 25,000 square feet in one of his Third Avenue buildings into 40,000 square feet in another. "Anybody who can delay, will," he said.
In another financial-services-heavy city, Charlotte, N.C. Charlotte's main real-estate profitcomes from its Charlotte Condos. Many real-estate players are holding their breath to see how Wachovia Corp.'s acquisition by Citigroup Inc. will affect office usage there. "It's still up in the air. We're in the eye of the storm," said Mike Kemmet, a vice president of real-estate brokerage Colliers Pinkard. Wachovia had been slated to move into a 48-story office tower, now under construction. Citigroup hasn't detailed its integration plans. The vacancy rate in Charlotte rose 0.4 percentage point to 11.9%.
The worst-hit office markets continue to be the ones bearing the brunt of the housing crisis. Businesses tied to the housing industry, such as home builders, engineers and mortgage lenders, have evaporated, leaving behind acres of empty cubicles.
The San Bernardino-Riverside, Calif., area saw its office-vacancy rate increase 2.6 percentage points in the third quarter and is up 6.8 percentage points in the past 12 months to 18.4%. Rents there declined 1.9% to an average of $18.88 a square foot last quarter.
Another hard-hit market is Tampa-St. Petersburg, Fla. Its vacancy rate grew 1.7 percentage points last quarter to 15%. Rents fell 1.8%. Alan Feldshue, managing director of office services at Colliers Arnold, a real-estate brokerage in Clearwater, Fla., said tenants are holding off on leases, wary in general of the economy. Companies that are willing to expand, are getting showered with so-called landlord incentives, such as several months of free rent and renovation and moving allowances. "If you are tenant out there, it's a great time," he said.
By: Alex Frangos
Wall Street Journal; October 3, 2008
