As investors in commercial property and other assets, you and I know full well the importance of knowing what’s happening at any given time to the economy as a whole. So when I came across the most recent report from the Institute for Supply Management, I paid close attention to what it had to say about where we are economically, and what that might mean to future investment appreciation or decline. 

According to the report, the monthly index of manufacturing showed a nice increase from December to January, rising from 54.9 to 58.4. Two things about this are worthy of note:  one, this marks the 6th consecutive month of expansion, the fastest upward movement since summer of 2004. Two, any reading above 50 signals expansion, and that’s a good thing.

On the other hand, total construction, projected to decrease jut 0.5%, actually fell 1.2% in December on the heels of another 1.2% decline in November.

Home sales were reported up by 11% in December over the same month a year ago, while the U.S. non-manufacturing sector rose to 50.5 in January, just short of the anticipated increase of 51.

Mortgage applications, another good indicator, showed a rise for the week ending January 29 of 21%, with purchase volume increasing by 10.3%, and refinancing applications up by 26.3%.

From the Commerce Department, we hear that December factory orders increased by 1%, double what some leading economists had predicted. This marks the fourth month in a row where factory orders were reported up over the previous year’s results.

Productivity, of course, is another indicator we keep an eye on—if it remains strong, that’s always positive news for commercial property owners with manufacturing tenants. The good news here is that productivity showed a annual rate increase of 6.2% for the fourth quarter. Labor costs fell by 4.4%.

Good news also on the unemployment front where the national rate fell to 9.7% in January versus 10% in December. At the same time, 20,000 jobs were lost, but bad as that is, it’s still better than the 150,000 jobs lost in December.

In case you didn’t catch it, the government has released reports showing that the gross domestic product (GDP) for the fourth quarter of 2009 rose at an annual rate of 5.7%, the best advance in six years. That’s an encouraging sign, but only if it continues in that direction.

Technically, the upward trend over the past two quarters could mean a technical end to the recession—but only if the weak jobs market manages a turn-around. We still are a bit hesitant about the prospects of 2010 for commercial property, but at least we’re pointing now in the right direction.
Business inventories have been increasing since October, with a 3.4% growth reported that makes it the best contribution in a quarter century. As that replenishment continues, we can interpret that as a positive development for warehouse and distribution properties.

Likewise, the report shows a rebound in consumer spending (1.4%), a somewhat tentative sign that consumers are starting to spend money. That’s good news for shopping centers and retail stores everywhere, assuming it continues to increase on its present path. It should be noted, however, that spending levels are still below what they were before the recession. Government policies will continue to affect consumer confidence, as always.

Naturally, the performance of retail properties is tempered along with reluctance among consumers to increase spending significantly. The report shows that, during the 4th quarter of 2009, there was an increase in national retail vacancy to 9.9%. Look ahead to 2010, we’re expecting that to grow to around 10.5 or 10.6 percent. Should that happen, you can also expect to see rent decreases of as much as 2-4%.

Other commercial property statistics from the reports show declining Owner-user purchases and construction of new facilities (15.4%), suggesting that the number of commercial property buyers is still relatively low. You may want to keep that figure in mind if you have a property you’re looking to sell during the coming year.

The news from the 4^th quarter of 2009 was better than expected, according to many market analysts, especially in that all important gauge of office rentals. For many investors, office rentals tend to reflect what’s happening in the economy overall.

When rentals go up, the business climate Is healthy. When it goes down, the message read by many is that businesses are generally contracting, choosing not to risk new space and overhead in the anticipation of uncertain times.

Job statistics across most sectors, of course, continued their downward slide right up to the end of the year. Even so, the office market in the U.S. posted a somewhat unexpected positive new absorption for the last three months of the year.

U.S. jobs data reported an increase of 48,000 office jobs in December. Even the financial sector posted an increase of 4,000 December jobs, the first increase since July 2007. Overall, office-using employment is up 154,000 jobs since the end of August 2009.  For commercial property investors—including those who are on the sidelines awaiting for a market turnaround—these numbers certainly merit closer examination. 

The turn-around may not be here yet, but the waters are apparently beginning to stir up.

In their quarterly State of the U.S. Office Markets webinar, CoStar Group Inc. reported a positive net absorption of about 6 million square feet for the quarter, which is about 6 months earlier than was expected.  Gross leasing activity grew from about 60 million square feet of activity in the first quarter of 2009 to more than 90 million in the fourth quarter.  While this is not exactly a record setting rebound that some have been looking for, it certainly can be called a very nice little bounce.

Time will tell just how significant that last quarter really was.  As the economy stabilizes, it could take some time for positive numbers to flow fully through to the office market. Recent GDP reports have been encouraging, but there is still a lag in hiring across the board—as often happens with a recession.

Notwithstanding the bright spots in office jobs market, we could still see net negative absorption all through 2010. What will be interesting is whether the fact that this is an election year will speed up a recovery to any noticeable extent.

Nationally, that absorption bump in the 4^th quarter brought the national vacancy  rate to about 13.1%, but total office space availability is still increasing to almost 18%. That may put a damper on the reported Q4 positive absorption over the short term.

Rents, incidentally, are expected to continue their downslide even as demand stabilizes. Office rents nationally declined by almost 10% on the average.  Many landlords outside the largest metro areas are using concessions to entice new tenants, holding off on rent reductions as long as possible.  At some point, barring a truly big bounce in the economy, asking rents may have to be slashed even more. That’s why the news about rising office market statistics have some wondering if the cavalry may arrive in time, after all.

Opportunities may exist as distressed assets are purchased by well-capitalized ne owners with lower debt obligations. They could be in a strong position to undercut the competition, but of course this in turn pulls down market rents within any given market area.

It should also be noted that differences still remain between different geographic areas. New York reported 1.6 million square feet of positive new absorption, whereas Orange County, CA, posted negative net absorption of 1 million square feet, and San Francisco, 900,000 square feet. The three western states, WA, OR, and CA, combined for about 2.1 million square feet  in negative net absorption.

Here’s a quick preview of the year ahead, as compiled from such industry analysts as Marcus and Millichap:

The year 2009 saw a large uptick in store closures, especially the first half of the year, and while the weakness is expected to continue well into the new year, there are some early signs that there may be life in the retails sector after all. Excluding autos, recent retail sales data indicates some small glimmers of light at the end of the tunnel. Most sectors posted modest gains from August to September, with retails sales increasing by 0.5 percent. Granted, that is a nearly 5 percent decrease year over year. It could take another several months before we see significant improvements due to the slowing effects of  low employment, weak housing sales, tight credit, and a growing consumer inclination to save money. The numbers do show some bright spots, particularly among necessity-based retailers such as groceries and drugstores and dollar stores, all of which benefitted from consumer cost-trimming as the economy softened.

Softening demand among tenants contributed to a 45 percent decline in investment activity among single-tenant retail assets year to day through September. An evolving trend over the past few years has seen investors moving to quick-service restaurants and drugstores for better returns. However, fewer exchange sales and sale-leaseback transactions should hold down investment activity for the first 6 months or so of 2010.  With fewer active buyers, pricings are seen to be declining somewhat and cap rates have increased.

By late 2009, cap rates had pushed up an average of 90 basis points, and as that continues, some buyers will pull out of the market, we anticipate. Demand for lesser properties with at-risk tenants should remain weak through 2010 as investors and lenders avoid assets with a greater likelihood of going dark.

I’ve been asked this question by a number of my clients lately. Positive economic news has been slowly making its way into national broadcasts. Job claims are down—or at least not climbing as fast as they were a few months ago. Black Friday shopping  levels were up a bit.

So is there light at the end of the tunnel? Have we hit the bottom yet?

Unfortunately, the answer is no. The commercial real estate lenders we work with still see some problems ahead.
It’s true that some fresh capital is slowly starting to trickle into the sector, but you have to remember that massive amounts of debt scheduled to mature over the next several years will far outpace that. The degree of deleveraging the market needs to fuel the re-emergence of a strong lending market is being affected by any number of factors. 

In other words, months (even years) of market depression are likely still ahead.

Granted, loan funds are still available in some places. But that may not do you much good if you’re underwater.  For example, if you bought back in 2006 assuming that rents and occupancy would be increasing, then you’ve obviously missed your goals considerably. Add to that the tightening of loan underwriting standards and you see that the gap between existing mortgages and takeout financing is simply getting wider, not smaller.

Deutsche Bank estimates that maturing portfolio and commercial MBS loans will increase at the following pace:
$204 Billion this year
$207 Billion in 2010
$296 Billion in 2111
$338 Billion in 2012

It’s been reported that around 350 property and debt funds have raised an estimated $135 billion of equity since 2008. In addition, REITs have sold $15.6 billion in stock  during 2009 and floated over $9 billion of secured debt. Finally, just since August four mortgage REIT’s  lined up $1.5 billion through IPOs.

The problem is…it’s still not the amount of capital we need for a strong recovery. A recent report from Pru Real Estate Research stated that if the $2.8 trillion in mortgages taken out between 2005 and 2008 had to be refinanced in the current economy, the underlying properties would qualify for only $2 trillion in debt. That leaves a serious funding shortfall of $825 billion that would have to filled by new money or write-downs. 

How does this impact your current situation? What are the solutions and opportunities that may be at your disposal? The answers of course are different for just about everyone. It is only by sitting down with a well qualified, experienced and market-savvy investment manager or consultant that you will find the best path for going forward. Every client we meet with has his own particular challenges.

If you’d like to discuss this in person, send me an email at Michael@fmgrp.com or call me at 310-282-0788.

Recently I had the chance to tour the Hearst Castle up in Cambria, CA. If you’ve never been there, I advise you to run…not walk! It’s a great tour, and we have no idea how long it will be there.

Standing on one of the terraces overlooking the incredible Neptune swimming pool, the high, ornately decorated towers, priceless statues and tapestries, and gold leaf coated gates, it occurred to me that William Randolph Hearst would have loved the news earlier this month. According to the MIT Center for Real Estate, commercial property values owned by institutional investors rose 4.4 percent in the third quarter, the first increase in more than a year.

 Hearst Castle, of course, is owned by the State of California these days (and funded partly by my tour ticket at $24 a crack!), so Hearst himself wouldn’t have had a personal stake in the news, even if he hadn’t died in 1951. But I can’t help but believing the old guy would have enjoyed hearing that his pride and joy was finally up a notch or two in value.

 The importance of the MIT index report may be more that it’s one of the few recent positive signs out there, more than anything else.

Based on the value of property transactions in the NCREIF index, it relies on info for roughly 6000 properties. Even though the index is still 36% off its peak in 2007, it does reflect some of the first positive market sentiments in over 2 years. That’s good to know when you, as an investor, look over your current or prospective holdings.

Other good indicators from the index: a narrowing in the gap between what sellers are asking and what prospective buyers are offering for properties. Offers in the third quarter rose 12 percent, after declining for eight consecutive quarters, while accepted prices dropped 2.5 percent, and were 30 percent below the peak reached in mid-2007.

Naturally, a single quarter does not make a trend. But it beats another downward quarter for now.

I was reminded the other day about a very successful strategy we’ve used to upgrade and revitalize an existing retail center in order to maximize our client’s investment.

This particular shopping center, totaling 155,000 sq. feet, was located in the west San Fernando Valley of Los Angeles, California. It was originally built in the 1960’s and had been somewhat upgraded in the 1980’s but was never  maximized to its real potential. Lucky Food Store, HomeLife Furniture, JoAnne Fabrics, Pep Boys and numerous smaller local tenants occupied the center.

The owners were very positive about this center due to its location and demographics, so they decided to have us do what we could to maximize its potential.

Often that means negotiating with the largest anchor (in this case, Lucky–which was later merged with Albertson’s Food Chain),  to build a new 52,000 sq. feet store under a new 35-year lease at more favorable terms and rents for the landlord.

 We also negotiated with all the smaller local tenants to buy them out of their leases to make way for three new national tenants: Pet Smart, Harbor Freight Tools and Sav-On Drugs (now a CVS Store).  HomeLife Furniture was not doing well financially at the time so we suggested replacing them with HomeGoods, a chain under the TJ Maxx corporate umbrella.

In the end, we were able to almost double the annual rents and to increase the value of the center by over 50%.

Today the center is fully leased to all national retail tenants and looks like a newly constructed shopping center. It remains a tremendously valuable asset for the owners and a real benefit to the tenants and community.

Moral of this story: sometimes it’s helpful to step back and re-assess your facility, your tenants and your opportunities–even when all the economic signs are less than optimal.  Find yourself an experienced negotiator…and turn them loose…

So you’ve decided to invest in commercial properties…perhaps a shopping center. What do you do next? Many investors face that tough question. When reality sets in, the task of maintaining and running a commercial property can quickly become overwhelming, even to the savviest investor. That’s when—and why—you need the services of an experienced commercial property management company.

What can an experienced commercial property management company do for you? If you’re not getting the following, you’re not getting what you absolutely need…
1. Collect and deposit monthly rent payments for your shopping center.
While collecting monthly rent from your tenants can sometimes be difficult, a good property management company already has its own systems in place to ensure that rent payments are collected on time so as not to affect your cash flow.

2. Monitor your shopping center rental rates.
Your commercial property manager monitors the rental rates of your investments to ensure that they remain competitive. This can be a key factor in securing – and keeping – good tenants for you.

3. Rules, Regulations and Laws.
Commercial property managers stay abreast of all the local, state and federal regulations to ensure that your shopping center investments are in compliance and up to code.

4. Marketing and Advertising.
An experienced property manager is proficient with all the current online and offline marketing and advertising opportunities to promote your shopping center. These strategies will keep vacancies at a minimum.

5. Inspections.
The commercial property manager you choose should be vigilant in the maintenance of your shopping center through regular inspections. It is important that they find and fix any problems before they escalate into a larger issue before, during and after your tenant takes occupancy.

6. Securing Tenants for Your Shopping Center.
This can be a very time-consuming process. A good property manager will handle aspects of securing the right tenants for your shopping center by conducting all the necessary background/credit checks, credit reports, etc.

7. Professional Contacts.
Experienced property management firms have spent time over the years forging important relationships with suppliers, contractors, maintenance workers, etc. who can save you time and money when making changes or repairs to your shopping center.

8. Time Management.
Hiring a good commercial property manager to handle all the details concerning your center frees up your time to focus on other endeavors.

9. Remote Commercial Properties.
Because it’s not possible for you to efficiently monitor your commercial properties that are located out of your geographic area, an experienced property management firm can be a very valuable asset.

10. Financial Management.
Most commercial property management professionals also assist with your financial management strategies and charge investors a percentage of the monthly rental rate of the property, usually 3.5% to 6%. Savvy investors realize the benefits of a good property manager and gladly pay this fee.

We talk to lots of investors these days wondering if there’s any future in holding on to their investment properties…or if the risk is just too great. Once they decide to hold, their next question is always “How do we make it work?”

If you were sitting across the desk from me right now, here’s what I’d advise you to do:

1. Be upfront with any investors you might have.
Demonstrate how your experience and expertise (or that of your property managers) will lead you through the tough times.Transparency is critical.

2. Talk to your lenders.
Again, be upfront and open. Let them know exactly where you stand–your cash flow, your anticipated expenses, the risks, everything. Show why you’re confident that you will survive any contingency.

3. Preserve your cash.
 Hold off on any discretionary spending projects. Reduce or eliminate dividends and distributions. Cut operating costs wherever you can.

4. Revamp your business plan.
Revisit your original plan and determine how it adjust it to current conditions. This exercise alone will give you a new view of your path ahead, and force you to re-examine your options. Examine some worst case scenarios, and draw up some strategies you can follow should they come true.

In short, if you are to survive these trying times, you have to open your eyes to what’s really happen, and decide how to outlast it. And finally, be sure you’ve got well qualified  advisors in your corner who know the real estate investment industry inside and out.