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VOL. 124 | NO. 248 | Friday, December 18, 2009

Commercial Real Estate Hits Doldrums

By Eric Smith

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When it comes to trends, commercial real estate usually lags residential real estate, sometimes by as much as a year. So with the housing market showing its first signs of improvement during the last month or so, the commercial sector needs to prepare itself for a long, bumpy road to recovery.

Data from the past year reveals a bruised and battered commercial market, one that saw its lowest total in the two decades that real estate information company Chandler Reports has been tracking commercial sales.

Shelby County’s commercial sales during the past 12 months (November 2008 through October 2009) have totaled just 605, down 33 percent from 908 sales during the previous 12-month period and down 48.7 percent from 1,179 sales during the 12-month period before that, according to the latest data from Chandler Reports, www.chandlerreports.com.

In the period ending October 1989, the first year Chandler began compiling commercial data, sales totaled 1,166. In the 20 years since, Shelby County has averaged 1,141 sales, meaning the past year’s total is about half its normal rate.

Dan Whipple, president of Crye-Leike Commercial, said this recession has lived up to its billing as one of the nastier ones in recent history – but perhaps not as bad as some might think.

“It’s worse than most,” he said. “But you’ll hear people comparing it with the depression of the late 1920s and early 1930s, and I don’t think that’s true at all. And the reason I don’t is because our underlying economy is much stronger than it was then. The banking system, believe it or not, is much stronger.”

More to come

Despite a banking system that has kept the economy barely afloat, the downturn has taken a toll on commercial real estate. Sales during the past year have averaged $656,552, a 27 percent dropoff from $918,416 during the previous 12-month period and a 65.4 percent dropoff from $1.9 million the period before that.

As for the total sales volume, the decline is even more staggering. For the 12-month period ending October 2009, commercial sales have tallied $397.2 million – a 52 percent decrease from $833.9 million for the previous period and an 82.6 percent decrease from $2.28 billion the period before that.

The drastically reduced sales price average for commercial properties has negatively impacted values, but it also has been a boon for investors, Whipple noted.

“Because commercial prices are now depressed, or down substantially from where they were less than two years ago, this is the time that investors make money by buying property at the right price,” he said. “It’s really an investor’s buying market.”

Whipple said the bottom of the commercial market probably isn’t coming until the middle of next year, meaning there will be plenty of short-term buying opportunities for anyone with cash. Because of this scenario, he said the goal for commercial brokers is pairing all the buyers and sellers they can find, hoping to strike a deal that is right for both parties.

In this economy, that means helping a seller shed a property it can no longer afford, and helping a buyer locate the right investment acquisition that will yield a healthy return.

“What we’re trying to do is assist as many people as we can by listing their property, particularly if they’re people who have to sell their property,” Whipple said. “There are a lot of people who need to sell their property because of the economy. That’s further causing opportunities for people who want to buy property.”

Foreclosure havoc

While the past year in commercial real estate has been defined by a lack of financing and an inability for most businesses to pull the trigger on deals, the transactions that did occur were well outside the norm.

First and foremost, the rise of foreclosures wreaked havoc on the commercial sector, evidenced by the number of high-profile properties – from One Commerce Square to the former Harrah’s office building – that were sold ignominiously on the Shelby County Courthouse steps.

At least the No. 1 sale during the past year wasn’t a foreclosure. Instead, it occurred when a joint venture between Weingarten Realty Investors and Hines Real Estate Investment Trust (REIT), both of Houston, paid a combined $41.6 million for the majority share of two local Kroger-anchored retail centers.

Technically, they were two separate transactions, with the Commons at Dexter Lake at 1675 N. Germantown Parkway fetching $29 million for top honors in the county and Mendenhall Commons at 540 S. Mendenhall Road fetching $12.6 million for the third-highest sale.

But the second-highest sale during the past year was perhaps the most eye opening. One Commerce Square at 40 S. Main St. sold back to the lender in a successor trustee’s sale for $20 million following a foreclosure of the 31-story landmark tower.

After that, only two other sales – a NAPA Auto Parts distribution center and a car dealership – surpassed the $10 million mark.

Despite the lack of high-dollar sales, many of the buyers who did invest in Memphis once again came from out of town. That’s because with a looming commercial real estate bubble bursting or about to burst, Memphis’ undervalued property remains attractive for outside capital, noted Jon Albright, president of the Memphis Area Association of Realtors and partner at Investec Realty Services LLC.

But, he added, the city can’t rely on that revenue stream if it hopes to survive the oncoming storm.

“You’re always going to have some investors that are looking for that value-plus opportunity, and, yes, that’s still available here,” Albright said. “But we need to attract new businesses. That’s no different than any other community. That’s nothing novel. But we do need to figure out a way to attract more folks so we’re not just simply moving the pieces around.”

Partially bright spot

One of the commercial sectors that has seen some of its pieces moving around is multifamily. Apartment sales marked one of the few bright spots in commercial real estate, but even those sales are off their pace of recent years.

Still, aside from vacant land over one acre, apartments led Shelby County’s commercial sales during the 12-month period ending October 2009 with 72 transactions averaging $672,972. Multifamily was aided by a couple of big deals, most notably the $9.5 million sale of Wyndridge Apartments to Philadelphia-based Resource Real Estate Inc.

Warehouses came in second in property type with 61 sales averaging $792,769. That sector was followed by office buildings (44, $876,995) and single-tenant commercial properties (44, $393,735).

Blake Pera, senior vice president for CB Richard Ellis Memphis’ multifamily division, said despite multifamily properties generally being considered safer investments because an owner can spread the risk among a high number of tenants, even that sector was hit hard by the financial meltdown in the fall of last year.

“The hangover from the collapse in 2008 was still felt well into the summer of 2009,” he said. “Demand has certainly increased the second half of this year, as significantly more buyers have re-emerged from the sidelines, giving us great momentum going into 2010. However, there remains an imbalance in supply and demand. We do expect to see an increase in the product coming to the market, but primarily from motivated sellers.”

Pera said the start of 2010 should be more of the same, although the outlook for the second, third and fourth quarters of next year portends brighter days for the multifamily market, which has long attracted interest from out-of-town buyers.

“There is a lot of pent-up demand from buyers, so many are expecting a more active transaction environment,” Pera said. “Multifamily properties should firm up starting in the spring as Memphis is expected to produce more jobs combined with a significant reduction in new multifamily starts.”

Looking for answers

Commercial real estate has more questions than answers right now, especially with low occupancy rates jeopardizing owners’ ability to avoid defaulting on their loans.

Without a doubt, there is more shakeout coming with regard to foreclosures and investors’ ability – and willingness – to tap into the soft values. Also, the U.S. Congress holds some cards. Whipple said the possibility of the government raising the capital gains tax is “frightening to investors.”

As one of the worst commercial real estate markets in this lifetime toils on, the industry is doing its best to brace for the bottom and begin the long climb back up.

“We’re all feeling our way along here,” Whipple said. “We’ve never seen anything quite like this.”

PROPERTY SALES 61 262 16,169
MORTGAGES 28 132 10,054
BUILDING PERMITS 88 424 38,360
BANKRUPTCIES 36 92 7,564