Earnings season is likely to be unkind to one sector of the economy – commercial real estate.
Office rents are down 8.5% since last year. Vacancy has risen to 16.5% – almost one out of every five offices or retail spaces are currently sitting empty.
Simultaneously, many large REITs are facing a slow-drip death. With tenants abandoning properties, and with many mortgages scheduled to reset between now and 2012 – and in a credit environment where banks are loathe to refinance – a number of commercial real estate groups are preparing to walk away from properties.
As one real estate executive told Tom Dyson of Daily Wealth, “Nobody can refinance their loans. You have to be able to roll your debt. But if the property isn’t worth as much as the debt, you can’t roll it over. And there’s a lot of debt coming due soon.”
Speaking about his own company, the executive said, “We were fine… but we’ve slowly lost tenants. Now we’ve got a couple of buildings where rent doesn’t cover the mortgage. We’re giving these buildings up soon. It’ll damage our reputation. We’ve never given up property before. But we don’t have a choice.”
The weakness in commercial real estate isn’t a surprise at this point in the recession. What is surprising is how well the sector has performed recently, despite shaky fundamentals.
Boston Properties, for instance, is up over 47% the past six months. SL Green, the biggest landlord in New York City, is up 214% over the same time period. This despite the fact New York has some of the highest commercial vacancy rates in the country.
Regardless of the high valuations, experts don’t expect commercial real estate to recover before 2010, at the earliest. “Any meaningful recovery is not likely to occur before the second half of next year,” National Association of Realtors chief economist Lawrence Yun said in an August statement.
Considering the conditions needed for a recovery in commercial real estate – specifically, falling unemployment and rising consumer spending – even optimists are pointing to the third quarter of next year as the beginning of the upswing. The good news – things may not get worse between now and then.
SL Green and Boston Properties are releasing their third-quarter earnings on Oct. 26 and 27, respectively. Even with a strong recovery, current stock prices are likely unjustified. If the third quarter numbers confirm continuing weakness, the stock prices of these and other commercial real estate companies could take big hits.
No matter how well other sectors do this earnings season, commercial real estate should be avoided – but watched closely. If the news is dark enough, commercial real estate still has the power to touch off another broad move downward for the market as a whole.
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