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Saturday, Jun 3, 2023

Commercial Real Estate Outlook for the Near Term

Since our last market report in July, much has happened to the financial world as we know it. Congress has just approved a $700 billion bailout. Unemployment levels are rising and approaching all-time highs. Our largest banking institutions are filing for bankruptcy, and the fears have spread internationally. These are some of the most significant and historic economic events of our time and feelings of fear, uncertainty and doubt are everywhere. Given this turmoil, we thought it would be useful to make some predictions for what we expect for the remainder of 2008 and into 2009. The Economy The US economy continues to churn out a barrage of negative news that is causing tremendous concern to consumers and business owners. We expect this to persist as the economy continues shifting to a recessionary environment with caution being the theme for most business owners. Many very experienced and knowledgeable business people are flat out scared. Many of the experts believe that this is only the beginning of what is expected to be tough economic times for the balance of ’08 and ’09, possibly into 2010. The latest news includes major financial entity failures, increased inflation, higher food and energy costs, higher unemployment and many within certain other industries on the brink of bankruptcy, i.e. airlines, automakers, etc. It is almost inconceivable to think that some of our largest financial entities are gone: Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG, Countrywide, Washington Mutual, etc. Wow! $700,000,000,000 financial bailout! Again, wow! Some experts question whether this may be just “the tip of the iceberg” as the FDIC list of problem banks continues to grow. Consumer confidence reports are among the lowest seen in 16 years. This barrage of negative economic news will slow consumer spending through 2009. As the consumer stops spending, manufacturers and distributors end up with increased inventories, which will require less space and laborers to manufacture and distribute the product, and so on, and so on….the trickle down effect. No one can accurately predict the precise moments of a recession or a turnaround, but we see this recession as one in the early stages with more challenges to come. Commercial Real Estate Investment Market A commercial / industrial real estate value correction is underway. The credit crunch that has affected Wall Street has spread to all financial institutions creating a high level of perceived risk associated with real estate lending. This situation has gone on for most of 2008, and many predict it will continue through the end of the year and into ’09, thus limiting the amount of investment sales that can occur. Many experts are predicting significant problems in the commercial mortgage backed securities (CMBS) market, similar to the residential mess that has been plaguing the U.S. economy for the last twelve months. Year to date, 2008 investment sale transactions are 30 percent of 2007 volumes, a dramatic decrease. Cap rates are headed up and real estate values are down, even though the scarce amount of sales transactions have not fully confirmed this. Investors are requiring a higher yield these days. We expect cap rates to rise 200 basis points since the peak of the market in 2007. The “gap” between buyer price expectations and seller price expectations remains intact with very few sale transactions occurring until new benchmarks for cap rates are established. This has resulted in a virtual freeze on investment transactions. We believe this is about to change as sellers begin to come to grip with reality as a result of the current financial crisis. Obtaining commercial real estate loans is increasingly difficult with most lenders tremendously concerned about risk. Lower loan to value and higher rates have been the result of this. Some lenders, particularly banks, are completely out of the game. Local Industrial Market The average industrial user in the San Fernando Valley and Ventura County region is not in a growth mode. The region, however, benefits from a very diversified base of industries that will mitigate the “pain” from the current market slowdown. Sales and leasing activity are at the lowest levels we have seen in five years. Vacancy rates will continue to rise and user activity will be restrained. The “trickle down” effect as a result of consumer spending restraints will begin to impact industrial users in 2009 as the consumer becomes increasingly affected by our recessionary environment. Lease rates and sale prices will be impacted to the downside because of supply and demand scenarios due to the economic slowdown that most users will realize in 2009. Slowdown in activity is expected for all building size ranges and will result in downward pressure on lease rates for the midterm. Increased rental concessions and reduced sale pricing will be the norm in 2009. We expect corrections in real estate values to be in the range of 20 to 35 percent, and perhaps more for inferior assets. The next several months are going to bring about significant short term change, and probably pain for some. We are reminded, however, where there is change, there is also opportunity. John DeGrinis, SIOR is a senior vice president with Colliers International in the Encino office and leads Team DeGrinis, which includes Patrick DuRoss, Jeff Abraham and Kate Borden.

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