Commercial Real Estate Construction Spending Takes A Dive

Investment in commercial real estate construction fell off a cliff in the fourth quarter as U.S. gross domestic product (GDP) shrank by an estimated 3.8%.

The Commerce Department reported today that fixed, non-residential investment decreased 19.1% in the fourth quarter, compared with a decrease of 1.7% in the third quarter.

“It’s really only in the fourth quarter that things derailed for a lot of industries, and at this point we know that it’s also derailed for commercial real estate,” says Victor Calanog, director of research for New York-based real estate research firm Reis.

Unless credit conditions improve, Calanog forecasts that the default rate on commercial mortgage-backed securities (CMBS) will breach 5% by the end of 2009. That figure, if realized, would be double the 2.5% default rate initially projected, according to Reis.

The GDP report offered few surprises to economists. “It corroborates what we know, which is that there are very few construction starts out there right now,” says Bob Bach, chief economist with brokerage firm Grubb & Ellis based in Santa Ana, Calif.

Commercial real estate construction starts rose a meager 2% in 2008, compared with an increase of 21% and 7% in 2006 and 2007 respectively, according to McGraw Hill Construction.

The one bright spot in the report was that it was not as bad as expected. The consensus of economists, says Bach, was that U.S. GDP would shrink by more than 5%. (The figures are subject to possible further revision.)

“Whether it’s minus 5% or minus 3.9% doesn’t really change the storyline. We’re in the midst of a severe recession, and we’re going to have some long-term effects on commercial real estate,” says Bach.

In addition to dismal commercial real estate investment in the fourth quarter, exports and imports also declined by double digits. Exports of goods and services decreased 19.7% in the fourth quarter compared with a contraction of 3% in the third quarter of 2008.

Meanwhile, imports decreased 15.7% in the fourth quarter following a contraction of 3.5% in the third quarter. “A really severe contraction of global trade is occurring and I think that has direct relevance for industrial space, especially around ports,” notes Bach.

“I think we’ll see industrial leasing market conditions deteriorate probably through 2009, but I think that’s true for all commercial real estate categories,” adds Bach.

The lack of trade is another indication that U.S. consumers are keeping a tight rein on their purse strings. Consumer spending in the fourth quarter fell 3.5%, following a third-quarter contraction of 3.8%.

The weakening GDP points to “continuing contraction in the consumer economy,” concludes Bach. “When American consumers are being that conservative, it has an impact that is felt across the globe.”

The big question is whether the Obama Administration’s nearly $1 trillion proposed stimulus package will help grease the skids of the economy and get it moving again. “We don’t know, that’s the thing,” says Bach. “We hope it will. We think it will.”

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