Market Shock

We have been here before.  We have been in a place where commercial markets were in a kind of suspension, where few sales were taking place, where foreclosures were much of the story, and where bargains for buyers were the other side of sellers’ misery.  We don’t even need long memories to remember.

The real estate collapse of 1990 was like a slow motion accident.  The Tax Act of 1986 had made investment in real estate much less attractive.  Investors who had bought condominiums for the losses they generated were no longer allowed to take those losses, and investors pulled out of the market.  Empty units piled up.  The market slowed and then fell.  By the time the falling was done, prices for apartments, office buildings, and industrials in Greater Boston were cut roughly in half.  Only single-family houses in the high-end suburbs and retail buildings resisted the price slide.  A bottom was found, and prices began a long, slow uphill climb.

In 2001 we saw it again.  Terrorists flew planes into skyscrapers, buyers went into panic, sales activity took a steep drop, and markets – especially the urban residential market – went into temporary suspension.  We waited for what would come next.  The answer came fairly soon: not a thing.  No more attacks came.  Sales, resumed, and from there we went on the buying binge that lasted until 2005.

So where are we in early 2009?  Is it 1990?  Or is it 2001?

Much of the early trend information we collect about real estate is anecdotal.  We hear of an investment that was to have happened at $8 million, but an issue that ordinarily would have been minor stood in the way, the deal came apart, and when another was put together the new price was $7 million.  A broker tells us that capitalization rates have risen – and prices, therefore, fallen – by 15% in six months.  We look at the fundamentals and see a mixed picture: reasonably stable rents and more or less stable vacancies, but a lack of construction funding.  Interest rates may be declining.  But hesitation is everywhere.

The hard data for real estate prices, unfortunately for people like appraisers who measure the market, consist of trailing, not leading, indicators.  Sales data come from agreements that were made months before, so what we see when we look at current sales is more a reflection of what was than of what is.  But the current “down” cycle has had more than a two-year life.  And current sales prices do show a trend.  

A study of the four major commercial market sectors in Greater Boston shows moderate price declines in transactions occurring in late 2008, versus the commercial market price peak of 2005-2007.  Sales of commercial properties in the last quarter of 2008 indicate price declines as follows:

•    for apartments in Greater Boston, from 5% (in high-rent locations) to 65% (in older, low-rent satellite city locations)
•    for offices, from 10% to 30%, with modern and well-located buildings showing little decline and older or poorly-located buildings in greater difficulty
•    for industrials in Greater Boston, from 10% to 30%, again with variation depending on quality and location

Not enough sales have occurred to allow strong conclusions for the retail sector.  The volume of sales of retail buildings – ordinarily about a third the volume of sales of apartments – is down 60% in the last quarter of 2008, in comparison to the volume in the same quarter three years before.  

Nationally, REIS, which tracks a large volume of transactions in commercial real estate,  reports a 17% drop in the average price per square foot for apartment buildings through December of 2008.  The Korpacz Real Estate Investor Survey tracks investment criteria for high-quality buildings, and, as can be expected for high-quality buildings, it finds a more marginal rate of change: from 1% to 11% for all four sectors nationally (as measured by changes in reported capitalization rates, which reflect changes in price).  The data from Korpacz are from the third quarter of 2008 and do not take full account of declines through the end of the year.  

The current evidence of price decline is one important indicator of the market.  Another is the decline in sales volume.  At times of investor and lender hesitation, markets go into suspension.  They did in 1990 and again, briefly, in 2001.  Markets go into a kind of shock that we see at the time as a cessation of activity.  Only later, when activity increases, do we get a clearer picture of the price point for the new bottom the markets have found.