Posted on Wednesday, August 31, 2011
We all know all too well that there are troubles in housing. Folks cant afford to pay their mortgages and homes are going into foreclosure. But what about commercial real estate, the shopping centers, office buildings and warehouses local industry and the economy rely on? You see the empty space everywhere you go. In shopping centers and office buildings across Palm Beach County and the Treasure Coast. What’s going on in commercial real estate? And what will it mean to you?
Commercial Lags Residential
Commercial real estate – retail, office, warehouse, hotels – lags behind residential real estate in both negative and positive impacts. So when the housing market crashed, it took about another year to really start seeing effect in commercial real estate. And when housing recovers, it will take more time for commercial real estate to fully come back.
The Ripple Effects
The connection between housing and commercial real estate is clear if you track the life cycle of dollars. In a nutshell, when home appreciate in value, folks have more money to spend and feel more confident spending it. Retail, office and hotel space to support that spending grows as does warehouse space to house and distribute goods in transit.
When housing crashed folks stopped spending, companies (the occupants of the commercial real estate space) contracted – laying off workers, cutting back on inventory and not longer needing as much commercial space. As more people became un or under employed and concerned about their income and more home values dropped, this process continued.
The businesses that counted on spending cut back on the space they needed and what they were willing to pay for that space. Unlike homes where values are based on what comparable homes in the area are selling for, commercial real estate value is based on cap rates or, essentially, the revenue it generates from rent. So as the space needs and rental rates went down, so did the value of the commercial real estate itself. This in turn often times trigger defaults under the loan documents which require that certain rent and occupancy levels be maintained. Much of this financing was provided by local community banks, already in trouble themselves. And as the loan matured – commercial loans are normally for terms of 3 to 7 years – refinance money was scare, even ore so for underwater properties.
We see this all over Palm Beach County and the Treasure Coast where the housing crisis and unemployment is even higher than the national average. In fact office vacancies are hovering at around 20%. Retail and warehouse at around 15%.
One high visibility example is the Bank of America Centre right here on Flagler, purchased in 2005 for $28 million with an $18 million loan. Rental income from office space was sufficient to cover the mortgage payments and expected to increase. Instead, when the real estate bubble burst, housing and the economy tanked, businesses cut back, and half of the space in the building has been now vacant since the beginning of the year. The same thing happened in City Place with retail tenants.
In many of these cases, the owners no longer wan the building and are trying to negotiate for a receiver to take over and a consensual foreclosure or deed in lieu of foreclosure or short sale no unlike many viewers who are now negotiating on their own home loans with their banks.
What Does It Mean To You?
In addition to seeing more vacant space, a different type of tenant mix, and expected slippage in repairs and maintenance on these spaces – since banks are concerned with selling the property to pay back their loan as opposed to the long terms interest of a project - perhaps the biggest impact this has on all of us has to do with the real estate taxes the County was counting on these commercial property owners to pay.
As we said, the value of commercial property depends on how much rent the property generates. So when rental income goes down, so does the value of the property itself. Since the real estate taxes we all pay is directly tied to property value, the real estate taxes also goes down. The problem is those real estate taxes help pay for much of the public services we all need – including police, schools, trash removal, rood repairs, you name it.
By some estimates, the budget in Palm Beach will have to be cut by as much as $50 million which means $50 million spent on these types of services will have to be cut (the other alternative would be to raise the amount we all pay for real estate taxes enough to cover this loss).
The bottom line? Expect to see serious cuts in services this year. And remember, since commercial real estate follows residential real estate recovery too, this trend is likely to continue for at least the next three years. Supporting local business ( perhaps as opposed to buying things on-line?) is one thing you can do to help turn commercial real estate in Palm Beach County and along the Treasure Coast around as quickly as possible.