Sunday, May 22, 2005

Even Commercial Landlords Are Losing Money

When the 1980's bust came to the oil patch, nothing fell harder than commercial property, as there was no use for it in the economic recession. It isn't surprising to hear the bubble is showing up in Californian office and manufacturing property. But it is odd that market fundamentals are being ignored. "Commercial properties for (the) hard-hit manufacturing sector are nearly 11 percent vacant."

"Matt Quaglino, who has built several office and industrial buildings in the San Luis Obispo area, says the price of land zoned for manufacturing has soared 170 percent in the last five years."

"Commercial properties and building sites around the county are fetching top dollar, and, except for in the downtowns in San Luis Obispo and Paso Robles, it's occurring even though demand is mediocre and rents are stagnant or falling. Industry observers attribute the trend to scant inventory and local investors flush with cash. They're betting that the escalating prices that hit the residential market will hit commercial sites here, too."

"Investors get much less return on their commercial holdings than they would have two or three years ago. Unless a buyer comes in with much more than a standard 20 percent down payment, they could be looking at several years of negative cash flow before rental income rises sufficiently to cover mortgage and operating costs. Some local builders strapped with skyrocketing land and construction costs are locking in quick profits by selling office space in new buildings rather than waiting for lease rates to catch up with development costs."

10 Comments:

At 11:08 AM, Anonymous Anonymous said...

Apologies for the off-topic post, but there's no 'general' category. Just seems to me that things are coming fast and furious now - anyone else have that feeling? I wonder just how sharp the transition will be - years, months, _weeks_??? Prepare yourselves - this might not be a pleasant ride for anyone... I really hope our senile Uncle Sam doesn't try to engineer a "fix".

-JJ

 
At 11:41 AM, Anonymous Anonymous said...

jj...it all boils down to the same thing IMO. There's just too much liquidity out there, so the price of almost all asset classes have been bid up to ridiculous levels.

Problem is, much of this has been paid for through record levels of debt creation. That could be the cause of a deflationary crash, similar to the great depression. As the loans go into default, the money the bond holders thought they had just disappears. And that is the definition of deflation...an implosion in the money supply.

I'm very worried about what's ahead. Will we have a banking/financial crisis fairly soon? (next 1 to 3 years?).

 
At 11:45 AM, Anonymous Anonymous said...

jj....:Just seems to me that things are coming fast and furious now"

Absolutely now question about it.

 
At 11:48 AM, Anonymous Anonymous said...

I've been wathcing the commercial real estate building boom in Michigan. There are high vacancy rates, but building keep going up. I think much of the commerical development is now primarily a real estate appreciate game not a rental income game.

 
At 1:15 PM, Anonymous Anonymous said...

**

Same thing here in SF. Commercial/office rents are pretty much where they were in 96-97 (as are apt rents) yet bldg's are selling for 200-300% of what they were in 96.

Of course, during 96-01, rents went up 3x thanks to the dotcom thing (you might have heard about it.) But that's all over now. Expecting an encore is like waiting for Halley's Comet (every 86 years).

The cap rates are now guaranteed to make every buyer a multi-year (or much longer) loser via neg cash flow. No one around here has ever seen anything like it. Most of the bigger buyers are pension funds, REITs, etc. They are playing with OPM (other people's money). The private players who are using TOM (their own money) are selling.

Does this scenario sound like the beginning of something or the end of something?

 
At 1:29 PM, Anonymous Anonymous said...

I'm far from an expert on Japan, but wasn't the problem there largely one of banks making real estate loans in the late 1980s for properties at bubble prices?

And aren't the banks are STILL holding these loans, although the properties are worth far less than the loans? As a result Japan has been in a deflation for about 15 years now. Does anyone else see that happening here? Seems like the same setup to me.

 
At 1:37 PM, Anonymous Anonymous said...

This was in last Thursday's Rocky Mountain News:
http://www.rockymountainnews.com/drmn/real_estate/article/0,1299,DRMN_414_3789270,00.html

"Toronto-based Brookfield Properties is expected to sell the 1.2 million-square-foot Republic Plaza - Denver's tallest high-rise - at 370 17th St. for $300 per square foot or more, fetching at least $360 million.

That would shatter the record for a total sales price as well as a per-square-foot price for a multitenant high-rise office building. "

The article goes on to say the building has an 18% vacancy rate.
Sounds like a high price to me, but I don't have any return numbers.

..DenverKen

 
At 3:14 PM, Anonymous Anonymous said...

"And aren't the banks are STILL holding these loans, although the properties are worth far less than the loans? As a result Japan has been in a deflation for about 15 years now. Does anyone else see that happening here? Seems like the same setup to me."

Highly unlikely. The Japanese likes to hide problems. We will start the blaming game at the first sign of the crash.

I expect falling prices in the next 3 years followed by stagnation.

 
At 4:18 PM, Anonymous Anonymous said...

(I have not seen, in the past two years, a single arms length, market sales transaction in the commercial arena that could be reasonably projected to produce a positive cash flow in the next five years.)

Very telling. As I wrote earlier, same here in NorCal. Mystifying. Almost sounds like VC investing---pouring money into a negative cash flow company in hopes of an IPO, acquisition or turnaround. But condos are not cancer cures. And there is no IPO market for tract homes. I understand the REITs and pension funds have long horizons (5-10 years+) and have to put money to work. But who are these other people? Speculators, I guess.

 
At 6:22 PM, Anonymous Anonymous said...

[I'm far from an expert on Japan, but wasn't the problem there largely one of banks making real estate loans in the late 1980s for properties at bubble prices?

And aren't the banks are STILL holding these loans, although the properties are worth far less than the loans? As a result Japan has been in a deflation for about 15 years now. Does anyone else see that happening here? Seems like the same setup to me.]

A few things:

1. The Japanese bubble was greatly exaggerated by circular financing (e.g. Land as a backing for buying stock, stock as a backing for buying land.) In the US prices have been driven by easy money instead. It's said that at one point the Emporer's Palace in downtown Tokyo was on real estate worth more than the ENTIRE state of California.

2. The Japanese banks are sitting on bad loans but they can get away with it because the average savings rate is 20%-30%. In the US savings has gone from 7% to 1% in the last decade. We have no cushion so the loans will default with no way to hide it.

Finally, Japan has been hit by competition from supremely capable Asian countries such as Korea, Taiwan and now China. All have fantastic labor at better prices than Japan. Japan also has the oldest population in the world and it drags them down.

 

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