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S&P: Hard Times Ahead for Commercial Real Estate

Via BusinessWeek comes some new analysis from Standard & Poor's raising some caution flags about commercial real estate due to the weak economy.

Rather than pricing, it's financial markets that are constraining development. Loans are more expensive and harder to get. In addition, securitization volumes remain very weak, though there are some signs of these flowing again after the total freeze late last year. It is always hard to tell how much of the decline in securitization is from a reluctance to borrow vs. a reluctance to lend, but this time around, the latter seems to dominate.

In dollar terms, offices are the largest component of commercial construction, and they're often the most cyclical. This time, however, offices seem less vulnerable than usual. Apparently, the peak has come before developers managed to overbuild as much as they had in the past. In 2007, they built 215 million square feet of offices, well below the peaks in 2000 (298 million square feet) and 1985 (350 million). CB Richard Ellis reports that the vacancy rate for the first quarter was only 10.2% for downtown office space compared with 10.8% a year earlier. However, the vacancy rate for suburban space has edged up to 14.9% from the most recent low of 13.6% in the fourth quarter of 2006.

The vacancy rate data could be misleading. As in 2001, high levels of subleasing could be concealing vacancies. According to Grubb & Ellis, sublease space rose to 81.9 million square feet in the first quarter, up almost six million square feet in nine months. Much of the problem stems from a few major centers, particularly Orange County, Calif., where many subprime mortgage companies have closed up shop.

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