Metro Phoenix’s commercial real estate struggling, but housing market may rebound by mid-2009

Posted By Mike Padgett

Dec. 12, 2008

The credit, expansion and unemployment struggles facing local and national economies could last into 2010, with a few exceptions attributed to lower oil prices and interest rates, according to the “2009 Real Estate Forecast” from Grubb & Ellis/BRE Commercial in Phoenix.

The report is a review of the metro Phoenix commercial real estate market and national economy. However, deep in the report released Dec. 11, in the review of land sales in metro Phoenix, are comments that suggest the local residential market is approaching a rebound. Although local housing analysts have said they expect the residential market to begin improving by late 2009, the new report says the bottom of the housing market “should occur during the first half of 2009.”

“The housing market is near the bottom,” the report says. “Housing led us into the speculative bubble, and housing will lead us out. With stabilization and improvement in the housing market, the land market will improve, as will activity in the office, industrial and retail sectors.”

The glimmer of hope is credited to a reduction in excess inventories of houses, low numbers of permits for new homes, reasonable rates for mortgages, and a reduction in prices sought for new and resale homes, the report says.

The final part of the solution to finding the bottom of the housing market, the report says, will be the reversal of home foreclosures. Once the foreclosure numbers begin dropping, it says, “the market will have hit bottom and will steadily improve from there.”

Global economics

Overall, the credit market struggles that began in the third quarter of 2007, and which escalated into a global financial crisis, has placed the national economy “in the midst of what could be a lengthy and prolonged recession,” Grubb & Ellis Interim Chief Executive Officer Gary H. Hunt says in the report.

“Although it is difficult to predict just how long and severe the current downturn will be, we believe that we have not seen the end of weakening consumer and business confidence, slowing manufacturing activity, and rising unemployment that is currently plaguing our economy,” Hunt says.

“At this point, we believe it most likely will be late 2010 before we begin to see a meaningful recovery throughout the commercial real estate industry,” Hunt continues.

The few bright spots in the industry include lower oil prices and interest rates “that will allow some commercial real estate sectors to recover quicker than others,” he says.

Office market

In the metro Phoenix commercial real estate market, office vacancy rates in 2006 hit a low of 12.7 percent, a level unseen for six years. But by the end of 2008, just two years later, vacancies reached nearly 20 percent, partly because of 3.8 million square feet in new office buildings added to the inventory, the report says.

The sudden increase in vacancies, with a projection of more than 21 percent in the coming year, is expected to translate into a significant slowdown in construction in 2009 because developers have hit the brakes on several planned projects.

The report says that with the magnitude of federal efforts to jump start the economy, “there should be some restoration of confidence during 2009.” The result should be a reduction in the uncertainty plaguing the market and increases in businesses taking advantage of attractive lease opportunities.

Industrial market

More foreboding numbers are found in projections of industrial space expansions. In 2008, projects totaling about 10.5 million square feet were completed. For 2009, only 3 million square feet of new industrial buildings are anticipated, the report says.

It says a marketwide vacancy rate of 13.5 percent in industrial space is expected by late 2009. That is only slightly less than the recent record vacancy rate of 14.6 percent set in 1993.

One bright spot could be the Southwest Phoenix submarket, which in late 2008 had a 20 percent vacancy rate. This submarket, the report says, “has the potential to have enormous leasing demand due to the main product type being warehouse/distribution” buildings.

“The fundamental drivers related to demographic growth, proximity to California as well as the relatively low cost of logistical operations, make Southwest Phoenix a location of choice as we move into 2009,” the report says.

It adds that, despite the weakened local and national economies, the metro Phoenix market’s “absence of natural disasters, ample power, water and a history of strong rebounding should help stabilize and expand the Phoenix industrial market over the next few years.”

Retail market

The metro Phoenix retail market “has slowed down considerably” because of a decline in consumer spending, negative job growth, a housing market still struggling to recover, and increasing vacancies in existing retail centers, the report says.

The report’s grim news continues: “As consumers continue to curb their discretionary spending, we expect more national, regional and local retailers to close during 2009.”

In 2008, the list of major retailers closing their doors in metro Phoenix included Mervyn’s and Linens & Things. Circuit City is closing 13 stores in metro Phoenix.

Retail landlords are facing a tenant’s market more difficult than in the past. This time, in addition to rising vacancies, tenants are seeking reduced rates, shorter leases and revising existing leases to lower rates. Four years ago, retail vacancy rates were about 5.1 percent. By the end of 2009, that could reach 11 percent.

Investment market

A few sentences in the report state clearly what’s happening in the investment market: “The amount of all investment transactions for 2008 was less than half the previous year. Sales are expected to be down again this year (2009) largely due to the lack of motivated sellers toward the end of 2008. It appears the bulk of the transactions in 2009 will consist of distressed assets where owners or lenders are highly motivated to sell.”

The report says sales volume in investments reached about $100 million annually in 2005 as well as in 2006 and in 2007. That total plummeted to about $30 million in 2008, with a similar total projected for 2009.

Land market

The major transactions for land in 2008 were finished lots for single-family homes, which were bought by investors at significant discounts. In 2009, home builders anticipating increasing sales will reenter the market.

“However,” the report cautions, “the primary land activity in 2009 will be ‘opportunity investors’ redeploying capital, once they are convinced that the bottom of the housing market is behind us,” the report says.

There could be some financial pain for lenders involved in land sales on the fringes of metro Phoenix. In these areas, the land “is likely to remain dormant for some time” because the debt on the land is more than the land is worth. The likely result is the properties going back to the lenders, who will have to absorb the loss. The result could push some lenders into insolvency, meaning that banks and the FDIC could become “major sellers of land over the next several years,” the report says.

The report adds that while residential land prices have fallen, land along freeway corridors remains strong, as are the values of land in the Southeast Valley, “especially around the Phoenix-Mesa Gateway Airport,” which continues to attract investors.

Multifamily housing market

One of the markets hit hardest by the current economic conditions is multihousing, which in 2008 reached a record low. In 2007, there were 126 multifamily housing sales, down 30 percent from 2006. But in 2008, there were 20 sales.

Owners planning to sell were facing property values below what they paid and less than their remaining debt. The report recommends that, unless the owners are willing to file for bankruptcy, or unless their lenders are willing to write off the difference between existing property values and what is owed, owners would be better off waiting until the market improves.

Finally, if there is one comment to remember when reading this report, it is this one: “Historically, the metro Phoenix economy rebounds much faster than the national economy.” The statement can be found on p. 7, in the Phoenix Investment review.

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Dec 12th, 2008

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