Commercial Real Estate: No Relief In Sight

Reis, the commercial real estate survey firm, said that occupancy of office buildings hit its worst rate in the US  since 1994. Reis said the rate at which the problem was growing has slowed. It is not unlike most of the “bad is not getting bad as fast” news that is part of the new optimism about the economy.

According to the FT, which reviewed the Reis data, “the vacancy rate in the US office sector climbed to 17.2 percent during the first three months of the year.”

It is easy to say that the office rental market has begun to bottom, but that analysis is incomplete and hides two important factors. The first is that landlords can no longer command high rent-per-square-foot, which means that their operating costs may exceed their revenue. Many real estate holding companies do not have access to significant amounts of cash, which means that they may  face defaults in the coming months.

The other results of high vacancy rates is that the wave of commercial real estate write-offs at banks will almost certainly worsen this year and in 2011. As owners of office buildings run out of capital reserves, they will return to financial firms for restructured mortgage terms. Some banks may offer those, but significant resets of loan provisions will cause write downs and damage bank balance sheets at a time when the government in on the lookout for any trouble within the banking system.

Banks will continue to be tempted to take over properties themselves because they believe they can carry them until occupancy rates improve or they can sell them at modest discounts to their mortgage values. Neither is likely to happen, so banks are faced with write-offs no matter what how they handle their office building mortgage portfolios. The theory that financial firm losses will be fueled by commercial real estate write-offs over the next few quarters is likely to be valid.

Douglas A. McIntyre