Commercial Real Estate Risk Remains Elevated Everywhere

The focus of this article is the commercial real estate market. Both national and local conditions are discussed.

The immediate issues with CRE continue to be the large number of CRE loans coming due over the next few years and the large number of development projects that have been partially completed and continue to burden community bank portfolios. Data from the Federal Reserve supports that, nationally, $350 billion to $450 billion in CRE debt is coming due per year through 2014.

CRE prices are likely to remain under pressure. Buyers are chasing a small number of non-distressed quality properties, resulting in higher prices for these particular deals.

However, overall prices will likely move downward somewhat as the proportion of distressed transactions grow. Based on Moody’s Real Commercial Property Price Index, prices are down nationally near 45 percent since the peak in early 2008.

Declines are expected to moderate throughout 2011. This is based on the annual economic outlook by Wells Fargo Securities, LLC Economic Group.

In Washington and Benton counties, there has been some improvement in the CRE market over the past year. The vacancy rate appears to have peaked in Q3 2009 in the professional office sector at about 22 percent.

This represents the overall vacancy rate for Class “A” and “B” properties, based on our research.

Since Q3 2009, the vacancy rate slowly declined to 21 percent in Q2 2010, before bumping up slightly to 21.3 percent in Q3 2010.

With respect to the Class “A” and “B” retail sector, the overall vacancy rate appears to have peaked in Q2 2009 at about 16 percent. The vacancy rate had declined to 14.2 percent in Q2 2010, but increased to 14.8 percent in Q3 2010.

The office/warehouse sector has also seen an improvement in the overall vacancy rate over the past year, but it remained high in Q3 2010 at 23.3 percent. It should be noted that the vacancy rates reported in each of the professional office, retail, and office/warehouse sectors of the two-county CRE market are at levels above the respective national averages at the present time.

The local market experienced positive net absorption in each of these three sectors in Q2 and Q3 2010. This trend needs to continue through Q4 2010 and into 2011.

The multi-family residential sector is many times discussed with CRE on the national scene. There has been marked improvement in the multi-family sector in Benton and Washington counties over the past year.

The overall Q3 2010 vacancy rate in the Benton/Washington county market, based on 25,560 units surveyed, was 12.54 percent. The multi-family vacancy rate appears to have peaked in the two-county area at about 15 percent in Q3 2009.

As we enter 2011, continued improvement is expected in the multi-family sector. Nationally, occupancy in the multi-family sector is reported at about 92 percent, and concessions are reported to be coming out of the market.

Obviously, improvement in non-farm employment numbers is needed to absorb the excess commercial space, nationally and locally, and bring stabilization to the CRE market.  Job growth needs to be re-established at the small-business level.

We should not underestimate the small business and CRE linkage. It is estimated that 80 percent to 85 percent of all goods-producing and service employment is by companies with less than 500 employees.

Poor sales appear to be the No. 1 small-business problem. An estimated 75 percent to 80 percent of all business bankruptcies result in a retail or office CRE vacancy.

It is said that “as goes small business, so goes CRE conditions.”

In conclusion, CRE risk remains elevated as we enter 2011. Completed projects are awaiting stabilization, and there is a refinance risk with the ability of cash flow to service debt.

On a positive note, the two-county area is experiencing increased leasing activity which is slowly lowering vacancy rates. This trend is expected to continue. 

Tom Reed is a partner in Streetsmart NWA, which produces quarterly reports pertaining to the residential, multi-family and commercial sectors of the real estate market. Company offices are located at 2804 Main Drive, Suite C, Fayetteville, Arkansas. The phone number is 479-575-9100.