An end is in sight for the depressed investment sales market, a healthy sign in an otherwise increasingly unhealthy commercial real estate industry, according to brokerage firm Grubb & Ellis. As more commercial real estate loans expire in 2009 and property fundamentals deteriorate, the volume of asset sales is expected to accelerate, particularly during the second half of the year. The expected upturn in property sales will lead to greater clarity on pricing, forecasts Grubb & Ellis.
Speaking at a media briefing in New York on Tuesday, Glen Esnard, president of the brokerage’s capital markets division, emphasized that sales activity will inevitably climb as a rising tide of balloon payments on loans comes due.
Transaction volume for office, industrial, retail and multifamily properties is down 67% to about $112 billion for the first three quarters of 2008 compared with the same period a year ago, according to Real Capital Analytics.
In 2009, borrowers will need to refinance about $36 billion of loans that were originated and packaged as commercial mortgage-backed securities. If property owners can’t obtain refinancing on favorable terms, the assets will likely have to be sold.
Currently, transaction volume is insufficient to obtain a clear picture on market pricing, according to Esnard. Most completed transactions this year have been on behalf of sellers who have raised cash through the sale of Class-A caliber assets, rather than from forced sales of lower-quality assets. Macklowe Properties’ sale of the trophy General Motors building in New York for about $2.4 billion represents one such transaction.
The current level of activity doesn’t reflect the “overall market valuation across a spectrum of assets in various markets,” according to Esnard. He expects transaction activity to increase as much as 15% in 2009. Toward the third and fourth quarter of 2009, there will be as much as a 30% increase in transaction activity over current levels.
Meanwhile, there is a growing consensus that commercial real estate prices will further decline from their current levels. Goldman Sachs and JPMorgan Chase & Co. estimate that the average capitalization rate — or initial return based on the purchase price — will ultimately rise to the historical average of 9.5%, up from the current level of approximately 6%.
Bob Bach, chief economist with Grubb & Ellis, forecasts that U.S. gross domestic product will be on the rebound during the second half of 2009, resulting in an annualized GDP growth rate of 1%.
Even after the economy rebounds, leasing market fundamentals aren’t expected to improve significantly until 2010 because commercial real estate leasing activity lags the economy. Leasing activity will also lag improvement in the investment sales market, which is expected to be more active in 2009 as distressed properties come on the market next year and fuel transaction volume.
The New York office market, which is at the epicenter of the financial services meltdown, is projected to experience a 7% to 8% annual decline in asking rents in 2009 and 2010 projects David Arena, president of Grubb & Ellis New York, In addition, net effective rents will dip 10% to 15% over this period as landlords offer more generous incentives to lure tenants.
The vacancy rate in the New York office market will reach 9% over the next two years, up from current levels of about 6.3%, according to Grubb & Ellis. And the market’s availability rate, which takes into account space coming on to the market in the next 12 months, will spike to as much as 13%, rising from the current levels of 10%.
To put those property performance figures into perspective, asking rents fell as much as 8% annually in previous downturns. And in the 1990 recession, the New York office market’s vacancy rate hit a historical high of 16.8%.
New office supply in the development pipeline is at modest levels, which ultimately could help blunt the blow to landlords. According to Grubb & Ellis, new office supply of about 2 million sq. ft. will be added to the New York market in 2008. And by 2010, an additional 3 million sq. ft. of new office space is projected to be added.