The low prices and interest rates stimulating sales of residential real estate have done nothing to help the market for commercial buildings.
The big deals for offices, shopping centers and warehouses that dominated much of the last 10 years in commercial real estate have been notably absent in recent months, as developers find they cannot obtain financing to buy or construct new buildings and potential tenants stay put or go out of business.
After a stellar run for much of the 2000s that saw a flurry of sales of hotels, shopping malls and other commercial buildings at ever-higher prices, property sales lost their appeal to lenders and investors.
Sales of office buildings in Los Angeles County plunged 63% from 2006 to 2008, according to real estate brokerage Cushman & Wakefield. In 2006, there were 221 sales of buildings larger than 25,000 square feet; last year, only 81.
Transactions are now so rare that it’s hard to determine what a property is worth, and few are willing to gamble on whether the time is right to risk millions of dollars.
“There is rampant fear in every segment of the market right now,” said Los Angeles real estate broker Bob Safai of Madison Partners.
“A lot of [investors] are on the sidelines because they don’t know where the economy is going,” Safai said. “They want to hang on to their cash and see where the market falls out.”
Part of the problem, he and others said, is that during the boom investors abandoned the traditional notion that commercial real estate should be held for a long period and instead engaged in highly leveraged purchases that were typically meant to result in quick turnarounds -- and fast profit.
The system couldn’t sustain all the leverage or borrowing and broke down, said real estate investment manager Bobby Turner, who estimates that the commercial real estate market has been out of whack for a decade or more.
“The last 10 or 15 years were abnormal,” said Turner, managing partner of Canyon Capital Realty Advisors.
Turner has about $1.5 billion that he could invest in real estate on behalf of pension funds and other large investors, he said, but he was not in much of a hurry.
“We are passing on deals all the time,” he said.
Sometimes, he said, there are drawbacks to the property itself: It might be priced too high, have too few tenants or be in the wrong location. Or, given the stresses of the recession, Turner might stay away from a potential deal if he’s not comfortable with the purchaser, avoiding borrowers who he thinks might be too quick to seek bankruptcy protection if the going gets rough.
Another reason properties don’t change hands is that the market is in such confusion that buyers and sellers can’t agree on what buildings are worth. Values have dropped, but by how much? Not surprisingly, buyers tend to see the market as worse than sellers do.
“Buyers might be overly pessimistic, requiring prices that don’t exist,” said Michael Adler, president of Adler Realty Investments Inc., which buys, sells and manages commercial properties. “The gap won’t close until buyers come up or sellers fold.”
The standoff between buyers and sellers has been going on since fall 2007, Adler said. “Buyers kept falling out,” he said.
Key to the market’s stagnation has been the credit crunch. As financial institutions tightened standards and lending slowed, money to buy real estate became unavailable.
One form of such financing, derived from the sale of commercial mortgage-backed securities, has disappeared from the market almost entirely. Lenders last year issued just $5 billion of these securities -- which consist of commercial mortgages bundled together and sold by lenders -- compared with $78 billion in 2007.
“They’re not a popular product, to put it mildly,” said Delores Conway, professor of statistics at the USC Lusk Center for Real Estate.
But when the securities were being bundled by investment banks and sold all over the world the real estate market was flush with cash. There was so much money, in fact, that the securities can be blamed for driving up office rents, Conway said. Investors used proceeds from selling the securities to buy buildings at record prices and then raised rents to help pay their substantial mortgages.
Now many businesses are in economic distress and having trouble paying those rents, which is contributing to a problem in another part of the commercial real estate business -- leases. Once investors buy a building they must lease it, to law offices, companies large and small, or retailers, depending on the property. Leasing deals are a huge business all on their own, contributing billions to the coffers of landlords each year.
But the number of white-collar companies moving into larger offices has dwindled since 2006, according to Cushman & Wakefield, while the number of businesses renewing their leases in their current locations has grown.
That’s partly because companies that might otherwise have moved up to fancier digs are trying to save money. Also, many landlords are reducing rent and offering other incentives to keep tenants from leaving.
Meanwhile, competition from other landlords, trying to lure new tenants, is heating up, driving rents down further.
“There was a full-court press to try to induce us to leave this building and move,” said Dennis Ellman, a partner at the Century City law firm of Greenberg Glusker Fields Claman & Machtinger. Faced with the potential loss of a large tenant, the landlord offered better terms, Ellman said. The firm just signed a $61.6-million lease extension for its offices on Avenue of the Stars.
Another law firm, Baute & Tidus, recently decided to take advantage of the weak market to expand its downtown Los Angeles offices and renegotiate its lease for a longer term at 2009’s lower rates, partner Mark Baute said.
The commercial real estate market will probably begin to stabilize by the end of the year, said Marc Renard, a broker at Cushman & Wakefield.
By then, banks will know what kind of support and restrictions they will be facing from the federal government, and more capital for investments could be available. Buyers and sellers should also be in closer agreement on what property is worth, he said.
“At a certain point, transaction volume has to pick up,” Renard said.