Job Losses Hit Commercial Real Estate–Hard

January was a bloodbath for the job market with 598,000 losses. The staggering number has the obvious immediate negative consequences–and then there is the secondary impact. With the slashing of jobs comes the slashing of occupancy rates in most sectors of commercial real estate. Hessam Nadji (pictured), managing director of research services with Marcus & Millichap Real Estate Investment Services, spoke to CPN about how employment’s devastating nosedive is impacting commercial real estate. CPN: The consequences of massive job losses have trickled down to the real estate market, but have all sectors of the industry been equally impacted? Nadji: The hardest hit sector is still retail because of overbuilding between 2005 and 2007, consumer spending and the effect it’s had on tenant bankruptcies and retrenchment among retailers. The second hardest hit is the office sector, which is experiencing a rapid rise in sublease space. Because of job cuts, we expect the vacancy rate to remain very high for the next two to four months. The lag effect on occupancies will really begin to show in the second and third quarters of 2009. With the hotel sector, there are three negative forces; overbuilding, business travel is way down and consumer travel is way down. The effect on the hotel market has been profound. Hotels react to the economy very fast because they are daily operations. The hotel sector is in for a very tough year in 2009, but because of its correlation to the economy, it will come back soon after the economy recovers, but we’re looking at 2011 or 2012 before we see that kind of improvement. The psychological shift doesn’t happen overnight; it takes people time to have the confidence to spend again. CPN: And what about the industrial market? There is a much shorter turnaround for developing an industrial property compared to, say, an office property; there’s a little more advance notice of market conditions, so is the industrial sector comparatively better off than other sectors of the commercial real estate market these days? Nadji: Industrial was doing well through the end of 2007, but there was some overbuilding between 2005 and 2007 because the market had become very tight. There’s a high degree of functional obsolescence, so there’s more of a need for new construction. CPN: At first glance, it seems no sector of the commercial real estate market is going unscathed as jobs vanish by the hundreds of thousands, but are some sectors faring better than others? Nadji: The apartment market is experiencing the lowest vacancy rate among all property types at 6.7 percent, so it is comparatively better. But it’s not immune to the downturn, so expect the vacancy rate to close down at 7.8 percent in 2009. CPN: While apartment vacancy rates are relatively low, why would they increase, considering that the single-family housing crisis is forcing many to rent? Nadji: We’ve studied patterns of prior recessions and when job losses are moderate, it doesn’t have a significant impact on absorption. But when it’s extreme, people tend to double up, move in with family and postpone plans for forming rental households. CPN: Is there any sector of the commercial industrial market that is not taking a bit of a beating? Nadji: Specialty niches of real estate tend to be a little less affected by the economy. Seniors housing, in general, is in good shape because it was not overbuilt and the demand side is positive due to the aging population. In the self-storage sector, people tend to cut back when losing jobs, but there’s always a baseline level of need for people to store their goods. And the reversal in home ownership because of foreclosures or downsizing does create demand. Also, manufactured housing and mobile homes are holding up well. They become more attractive when people are making less money and have less to spend on rent. CPN: So, with no to job losses in sight, what can we expect in the commercial real estate industry? Nadji: Looking at the economy this minute, no sectors are showing they’re going to be driving a lot of growth. Normally, a recession automatically creates pet up demand–financing and jobs become more available and that drives demand and recovery. This time, we’re trying to correct a high level of consumer borrowing and corporate growth from the last five to seven years. We have a ways to go before we create pent up demand. CPN: Any uplifting news? Nadji: Historically, when there have been extreme levels of contraction, they have been followed by extreme levels of expansion. Normally, you get a pop, but we just don’t know if this time around there’s reason to think we’re going to get a pop; however, there is a tremendous level of liquidity that will be pumped into the economy, and a tremendous amount of stimuli that will be put in the system. The liquidity injection, the stimuli and the initiatives to create jobs–that effect hasn’t been felt yet. Banks still aren’t really lending. But when those changes take effect, they’ll be very positive and we’ll start to recover in 2010. CPN: Just speculating, what does the future look like? Nadji: Commercial real estate lags the economy by about six to nine months, so it will take six to nine months of a sustainable pattern of creating jobs for real estate to recover. The apartment market will be the first to benefit from recovery, as it tends to show reaction the quickest, followed by office and industrial. The sector we’re really worried about is retail. Retail had overbuilding going in, and it’s facing structural change, not just cyclical change. For example, how you replace department store demand that’s vanished; and you have to take time to overcome the obsolescence of retailers like Circuit City. Redefining retail will take longer than the cyclical downturn of the office and industrial markets. We went from having a recession to having a financial crisis in fall 2008; the commercial paper market froze and short-term operational financing was interrupted, and that has a lot to do with the high level of job cuts. Higher vacancies have already started and will continue through 2009.