Monday, January 5, 2009

Office buildings - is it really this bad?

The New York Times has a gloomy piece today on the cycle of layoffs to subleases to vacancies to building owners not being able to pay the mortgages, thus leading to a potential "ticking time bomb." According to the story,

Many commercial property owners will face a dilemma similar to that of today’s homeowners who cannot easily get mortgage relief because their loans were sliced and sold to many different parties. There often is not a single entity with whom to negotiate, because investors have different interests.

By many accounts, building owners have been caught off guard by how quickly the market has deteriorated in recent weeks.

Rising vacancy rates were expected in Orange County, Calif., a center of the subprime mortgage crisis, and New York, where the now shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded from the economic downturn until recently by skyrocketing oil prices and expanding energy businesses. In Chicago, brokers say demand has dried up just as new office towers are nearing completion.

I would think a lot of it is lease dependent. Are there termination options? Are bankruptcies playing a role as tenants reject leases? I was always under the impression that, generally speaking, things were not overbuilt, although I was concerned about so much space in Chicago coming on line. Even some tenants are backing out of commitments at new buildings here. Frankly, I never thought I would see New York vacancies approach 10%.

And the fact that many buildings are in CMBS pools makes it all the harder to do workouts. It makes me want to look at one of my deal toys: a bottle of Pepto-Bismol with a plaque that says, "Remind Me Again Why We're Doing a Conduit Loan Elixir."

All in all, this is a great time to be a tenant, the best in a while. And some say this is the perfect time to buy, especially if there is any government help. The trick will be to wait and see whether any stimulus will create jobs and the need for offices. One interesting thing is the speculation that President-Elect Obama wants to create 600,000 new government jobs. If that is the case, there will be a lot of need for government leases and the guaranteed, AAA-rated cash that come with them. Smart landlords may want to start gearing up now. GSA leasing is very tricky.


Doug Cornelius said...

I also found the article was gloomy. But I also found that it did not capture the operations of the commercial lease market.

Office buildings are still trailing the economy. As you point out, office leases are usually long-term contracts with no right to early termination. Other than the bankruptcy filings, the current layoffs and downsizing is not creating any new prime vacancy. It is starting to create more sub-lease vacancy.

Certainly there are many over-leveraged properties that cannot support their current debt levels. We will see more distressed loan issues (the loan is having trouble getting refinanced at the existing principal amount) even though monthly payments can still be paid.

2009 will be interesting for commercial property.

David Stejkowski said...

Doug, thanks as always for your insightful thoughts. I think the article misses the point that subleasing is different from vacancies, as landlords still get their money. Termination rights are not that common, and even then there are penalties and fees collected in those events.

As you know, landlords do not like seeing the market slip from them as tenants try to unload space. This is yet another reason why the assignment and subletting clauses in leases can be so important and are so often the most heavily-negotiated part of a lease.

I agree that this will be an interesting year. And I hope your company's team will take advantage of it. :)

CountingSheep said...

I am in Orange County and am in one of those Equity Office, to ?? to Maguire to someone else buildings. We had to renew our lease in October. They were tough!! In the end there was not another space in the surrounding area that would make us want to leave. Maybe if we had to renew now we would have received better terms but as off October, we were not able to get a great rate. This anectodal story is probably worth less.

What I want to know is why Chicago hotel occupancy is so bad. I would have thought with the election night events, November occupancy would have been a bit better. Things must really be bleak in Chicago.

David Stejkowski said...

I think your anecdotal story is worth plenty. Some of it may have to do with the size of the space and the quality of the building and other factors about your company. It is interesting to see how individual negotiations go as well.

As far as hotel occupancy rates, I am no expert, but remember Chicago depends on convention business to fill rooms. I am not sure how good November ever is in the city. And we have a lot of high end properties on line or under construction. The election would imo have a minimal impact occupancy in the grand scheme of things.