If future historians were to write a book about the state of commercial real estate in this election year of 2008, a fitting title might be, “The Great Time of Uncertainty and Anxiety.” It's hard to recall a period when so many economic variables — including energy, employment, housing and the financial markets — carried such high importance simultaneously and whose outcome was so unpredictable. Add to the mix of uncertainty a real donnybrook of a U.S. presidential race.
Developers and owners want answers to several critical questions: When will financial institutions stung by subprime mortgage write-downs turn the lending spigot back on for commercial borrowers at favorable terms? On average, how much will commercial property values fall from peak to trough in this down cycle? When will employers start hiring again? Will the price of oil per barrel stabilize at $100, $125, $150, or none of the above? And those issues are just the tip of the iceberg.
“Commercial real estate has been caught up in this broader web of issues and problems around the credit markets,” explains Robert Bach, chief economist with brokerage firm Grubb & Ellis. “The housing prices are going to have to bottom out before we finally see an end to this. Once we know what the losses are, at that point banks can finally deal with them and get their act together and begin anew.”
The latest data on home prices certainly doesn't offer any immediate comfort. The Standard & Poor's/Case-Shiller index, which tracks housing prices in 20 markets, reported that home values dropped 15.9% in the 12 months through June.
How acute is the current credit crunch? For starters, domestic commercial mortgage-backed securities issuance totaled just $12.1 billion during the first half of 2008 compared with $137 billion in the first half of 2007. “The competitive position of the securitization market remains weak,” wrote Sam Chandan, chief economist of Reis, in an Aug. 27 capital markets briefing. “The CMBS market faces significant challenges from a loss of investor confidence in institutional and structural relationships,” added Chandan.
Compounding the problem is that bond investors fear a spike in loan delinquencies and defaults in commercial real estate as the economy weakens. In one week alone in mid-August, the spreads on AAA-rated CMBS widened about 37 basis points to 305 basis points over 10-year swap rates. That's an increase of about 200 basis points since the start of the year, ratcheting up the cost of borrowing.
One line of thinking among economists is that the labor downturn continues to be surprisingly mild, spurred primarily by problems in the credit markets, says Bach. Another line of thinking is that the worst may be yet to come. The temporary help sector has taken the brunt of the blow, accounting for about one-third of the 463,000 jobs lost during the past seven months. After reducing their temporary staffing needs, however, more employers could be forced to lay off full-time employees.
“There are two schools of thought among economists,” says Bach. “We're at a tipping point right now. We're going to find out: Which is it?” Will the labor market face deepening job cuts, or will shallow losses be followed by recovery? Recent layoffs have been minor compared with the start of prior recessions. The health care and social services sector have eased the pain by adding 245,100 net new payroll jobs since December.
Employers have kept their payrolls relatively lean in recent years, even during the good times. “There isn't as much slack in the employment rolls,” says Chandan. In past economic booms, companies were more willing to hire workers in anticipation of future business growth.
The worsening credit markets signal that greater job losses are likely ahead, emphasizes Bach. But he is quick to point out that there is credible reason to conclude that the economy will slip through this downturn with minimal long-term damage. Net exports of goods and services added 2.42% to second-quarter GDP, the largest contribution since the third quarter of 1980. GDP would have fallen 0.5%, if not for the net exports.
The next few monthly job reports will be critical in determining the severity of this downturn. In the meantime, the year of uncertainty and anxiety marches along.
Contact Editor Matt Valley at matt.valley@penton.com.