How Long Can You Hold Your Breath?
Commercial Real Estate income lags the larger economy.
The lag has been seen with each prior recession and all evidence suggests a
continuation of this trend. The challenge for participants is to quantify the
impact of this recession on the depth and duration of price reductions. Lack of
agreement between buyers and sellers on pricing has contributed to a sharp drop
in transaction volume. To remove the log jam, the job of the Researcher is to
explain the boundaries of likely scenarios. In this short piece, I describe the
possible drop in pricing based upon plausible declines in occupancy and rental
rates. These assumptions lead to a prediction of office property income
reducing by 38% with the decline lasting into 2011. Combine this with an
increase in the cap rate from 7% to 10% and
we are facing a value
decline of nearly 60% by the end of 2010.
The table below breaks it down in a gross
Sources: 2007 Cap Rate: Real Capital Analytics, 2007
Rent: CoStar Group, 2007 Occupancy: NCREIF
So what do you do if you are an owner, tenant, broker, lender, or other interested party? Where can you make money, or at least lose less money, considering this prediction? The answer varies by your current position and long term strategies. However, the key is to think long term. There are few, if any, low-moderate risk strategies which will be profitable in the short-term. Future editions of this newsletter will explore possible strategies for market participants. However, before I progress too far, let's explore the assumptions which lead to these predictions.