In a commercial real estate market already suffering from a prolonged recession, the recent release of a bleak report was like tossing a Molotov cocktail into an already-burning (and half-empty) office building.
The report, “Commercial Real Estate Losses and the Risk to Financial Stability,” produced by the government group that oversees the Troubled Asset Relief Program, warned that nearly $1.4 trillion in commercial real estate loans (more than half of them underwater) will come due for refinancing over the next few years, which could result in a wave of mortgage defaults (to the tune of $300 billion), bank failures (especially among community banks — important lending sources for local businesses), bankruptcies among property owners, and, ultimately, the protraction of an already-historic recession.
“When commercial properties fail, it creates a downward spiral of economic contraction: job losses, deteriorating storefronts, office buildings, and apartments, and the failure of the banks serving those communities,” noted the panel in its report.
Compounding the crisis is the fact that some desperate business owners are now beginning to follow the lead of homeowners who are underwater on their mortgages by simply walking away from properties they can’t afford. And it’s not just mom-and-pop businesses: Even major commercial leaseholders like New York-based Vornado Realty Trust recently said it would default on two loans totaling $235 million, The Wall Street Journal reports.
All this doom and gloom, however, does have a silver lining. For small and mid-size business owners, the economic climate presents some real opportunities.
“The run-up of prices up to a year ago was unprecedented and ridiculous,” says Herb Goldberg, director of the commercial division of City Connections Realty. Now prices have fallen by as much as 30 percent in some markets. Indianapolis, Detroit, Phoenix, Cleveland, and Atlanta have been especially hard hit.
Though the market has seen some stabilization lately, Goldberg says the time is still ripe for making “aggressive” deals with landlords. Landlords are now much more likely to offer incentives such as renegotiating monthly rents and the length of a lease, as well as foregoing the first month’s rent.
Goldberg understands the inner workings of the commercial real estate game not only as a broker, but as a small business owner himself. He’s the proprietor of two children’s craft stores — businesses that suffered a 30 percent to 40 percent drop-off in business at the height of the recession. He was able to renegotiate his leases to a lesser rate because, he says, “nobody wants to see an empty store.” He added: “Now what seems to be happening is, if you have a few years left on your lease, you can expand your lease — do a new, 10-year deal — but at a reduced rent.”
John Bartlett, who runs a menswear shop in New York, added that the current commercial real estate climate “is indeed creating opportunities to renegotiate leases” or to stop yearly increases by freezing a lease. Bartlett says he’s currently renegotiating his five-year lease, which he entered into three years ago.
The market also provides an opportunity for businesses looking to expand. Bartlett, who is also a designer, recently launched a women’s collection and is exploring the possibility of opening up a women’s store near his flagship menswear space.
Diego Recalde, president and chief financial officer of commercial real estate firm Concrete Stories, which works mostly with small and mid-size businesses, says such dreams might not be so farfetched. “The leverage has passed from the landlord to the tenant,” he says. “Tenancy is very important now, and we’re seeing better transactions for tenants [in regard to] pricing, free rent, build-outs [refurbishing of spaces], and lease terms.” And there’s another advantage to this down market: More and more businesses can now afford to buy their space, not just lease it. “Real estate was always a big boy’s game. But now, more buildings are going ‘condo,’ so in some office buildings, you can buy 2,500-square-feet of office space,” says Recalde.
Real estate, however, has always been a hyper local market. Yes, some areas have been hit, but other areas, often within the same city, are doing quite well. Take Nashville, for example.
“Each [submarket] is performing differently,” says Devin McClendon, a commercial real estate broker in the city. The city’s high-end retail neighborhood of Green Hills has seen little or no falloff in the price of retail and office space, and vacancies are almost nonexistent. “Rents there are as high as they’ve ever been and there’s a scramble to get retail space,” he says.
But the story is much different in downtown Nashville. Especially where office space is concerned, “landlords are making a very aggressive push to maintain their tenants.” He adds, “There is definitely more interest today than anytime in the previous 10 years in the concept of ‘Can we negotiate?’”