As Massachusetts’ housing market began to sputter in 2006 and more homeowners began to worry about how to pay their mortgages, economists pointed to a bright spot amid the chaos: The commercial real estate market was booming. Brokers were making deals left and right, and good financing was available for new projects.
But two years later, demand for commercial space is off-pace when compared to the last couple of years, and financing for deals or projects isn’t readily available. Still, industry experts are confident that any downturn in the market is a blip and not a crash.
According to the National Association of Realtors, “The slowdown in commercial activity was expected. Commercial activity follows economic activity, and the downturn in the economy which began in late 2007 has yet to end. Add to that the turmoil in financial markets resulting from the subprime mortgage meltdown, continued rising oil prices and job creation in negative territory since the beginning of the year, and it is no wonder that activity in the commercial sector has eased.”
In Greater Boston, that has certainly been the case. Office building sales fell to $153 million in the first quarter of 2008, down from $5.7 billion for the same time period in 2007, according to Real Capital Analytics, a global research firm.
But the Bay State’s commercial real estate market will weather the storm, said David Begelfer, chief executive officer of the Massachusetts chapter of the National Association of Industrial and Office Properties.
“I think that the problem we’re seeing right now is there is a lot of anxiety and uncertainty about where the economy is going with the volatility in the energy sector, with concerns regarding financing and with the fallout from the mortgage problem,” he said.
Although many businesses continue to grow, they seem to be pulling back from making commitments for more space, Begelfer said. But it’s more of a short-term problem than a long-term one.
“I think you have businesses that are holding off a little bit from making commitments or looking for space, even though they may be doing reasonably well and seeing a need for new space,” he said. “It’s mostly because they’re not sure where the markets are going.”
Indeed, Encino, Calif.-based commercial real estate investment firm Marcus & Millichap, attributed the downturn partly to negative psychology.
“Until late last year, U.S. economic drivers outside of manufacturing and housing had been on relatively solid ground,” according to the firm’s midyear report. “In the second half of 2007, health care, education, professional services, trade and tourism added 733,000 jobs, while construction, manufacturing and financial services shed 283,000 positions. Negative psychology and tighter credit markets have since eroded consumer and business confidence, triggering a downturn.”
The slowdown has also affected commercial real estate investors.
“We’re seeing a serious slowdown in sales of investment property,” Begelfer said. “There’s a spread. Owners are looking for high prices, and buyers feel the properties are overpriced. It has caused a bit of a paralysis in a normally very strong investment market.”
Begelfer attributes this slowdown to investors’ lack of a crystal ball.
“It’s just due to them not knowing where [the market] is going,” he said. Owners who want to sell insist the market is about to turn around, and point to low vacancy rates, increasing rents and limited supply, especially in Boston. But buyers hope prices will drop.
“They certainly don’t wan to pay a premium right now,” he said.
Begelfer expects this holding pattern to go on for the next three to six months, possibly a little longer.
“I do think that’s going to work out certainly come 2009, we’ll see the markets return to some normalcy,” he said.
Businesses that need to expand can’t hold off, and next year should bring more certainty about the economy. Prices will adjust according to the new information.
But investors and sellers shouldn’t hold their breath.
“It’s unlikely we’re going to see some clarity [in the next three to six months],” Begelfer said. “I think this year will be a lull.”
Next year’s market could be helped by a new president taking office, and new attitudes about the economy entering the picture.
“I think we’re going to see some return to some normalcy,” Begelfer said.
But this year, it’s not just investing in existing commercial buildings that has been difficult to find; financing for new construction has also been a challenge. While there are projects that still have strong backing – Begelfer mentioned some in downtown Boston, including Fan Pier, the mixed-use tower at the old Filene’s in Downtown Crossing and Russia Wharf – it may be more difficult for developers of suburban projects to secure funding, unless they have very strong pre-leasing, he said.
“Financing has been more difficult, no questions about that,” he said.
Some, like the smart-growth development Westwood Station, are still moving forward, but Begelfer said many others are probably slowing down.
Like Begelfer, Marcus & Millichap expects the downturn in the commercial real estate market to be brief, and called the current market “normalized” after a period of unsustainable, frothy conditions.
“Unlike past cycles, generally healthy commercial real estate fundamentals and a lack of significant overbuilding will limit the correction,” according to the report. “Furthermore, the last period of economic expansion was relatively brief, and companies remained cautious when hiring and leasing spaceÂ… Unless the downturn deepens unexpectedly, however, the increase in vacancy should be moderate, keeping U.S. averages below previous cyclical highs.”
Begelfer agreed.
“I think that we’re going to get through this, and Massachusetts in general has been slow recovering from the last downturn,” he said. “I think this downturn will be easier to get through [for Boston] than for some markets that have been more aggressive in the last few years.”
