With Declining Fundamentals, has the DC/Metro Market become a tenant/buyer’s market?

Implications: Timing is everything in business and life. With the drum beat of bad economic events all around us, there will become a tipping point whereby it will make sense for investors and tenants to take advantage of the downturn in the commercial real estate market if they survived to that point in time. The key question is when will the alarm go off?

Analysis:  This question can’t be answered with any real accuracy. The old adage says you never know when the market has peaked nor do you know when the market has bottomed. It is this writer’s opinion the commercial real estate market still has a way to go before it reaches its so called bottom. The declining fundamentals have just now become evident in statistics. The DC Metro market as the article points out reflects the plunge in investment sales throughout the region. It also goes on to highlight the lack of leasing activity. If you recall, most of the pundits predicted the credit crisis would be over by the Fall of ’07. This writer actually predicted that was just the beginning and pointed out how the contagion would spread. And spread it has. Just yesterday there were several media reports telling us how banks have across the board without exception tightened credit even more and have expanded their new stringent lending standards to all variety of loans. This tightening has occurred in the face of the Federal Reserve propping up the banking system. As this writer pointed out when the Fed started their banking bailout, their actions would NOT lead to any significant lending to both businesses and consumers. As a matter of fact, the situation has gotten worse. That report also pointed out that 80% of the banks in the survey said they don’t expect to loosen credit for at least another 12 months.    

So the question becomes how in the world can the economy stand up in the face of one of the most widespread credit upheavals in modern times? The answer for the realists is it can’t. When credit, which is the life blood of business, not just real estate, is cut off, which is what is essentially happening now, business falters. When the consumer which is responsible for two-thirds of the GDP can’t obtain credit, what happens? You all know the answer.  

Since commercial real estate is a lagging indicator of the economy and ultra sensitive to financing, and the reported fundamentals of rising vacancy, lack of tenant activity, and over building are just now kicking into play, this means now is not the time to take advantage. This market, as well as many United States MSA’s have not nearly reached bottom due to fact the credit markets are still 1 year away from any correction, or even being ready or wanting to get back into the lending business, and the 1 year prediction. is a big maybe!  

That being said you will start to see much more pain become inflicted on the commercial real estate market. Companies are laying off workers all over the place, job growth even in the DC Metro market is off 50%, and yes the area is thankful there is still positive job creation, but this can not last. Government spending has been greatly reduced in the area, local companies can’t fund new projects, and with the uncertainty in the economy many companies are on the sidelines waiting to see how this all unfolds.  

Does this mean business comes to a complete halt? No not at all, but it will sure seem that way especially after the way it had been going between 2003-2007.  

As the economy continues its slide, it will be a while for the commercial real estate market to feel the full impact. What you should be looking out for are defaults by the non-institutional investors who bought during the boom, at very thin margins, 4.5%-6% cap rates, with the expectations of higher rents down the road and a low vacancy market. Also keep an eye on the large amount spec office construction going on here in DC Metro that is being built as this is being written with no prior leasing commitments. When you see those spec office properties going into default that will be the best time to strike. Tenants will be able to make sweetheart deals for themselves if they have the guts and foresight, and investors can jump back in if they have cash in their pockets or foreign money, and begin buying probably at 50-70 cents on the dollar. Remember REIS and Moody’s and other data companies have already suggested the market has lost approximately 15%-20% of its value in the last year alone. Please discount the scant recent sales by foreign investors at record prices around DC. The currency play made that possible.  

Therefore those tenants that have a year or so to go on current leases, start getting your ducks in a row because you won’t want to miss the next great tenant’s market. You’ll get favorable lease rates, and wonderful concessions such as free rent, higher work allowances at no additional charge, and a host of other benefits, and the best part you will be able to upgrade your space or address. And if you just want to renew at your current location you will still be able to get a great deal too, and don’t worry about your high priced option rental rate or annual escalations. If you are occupying a decent amount of space in your current bldg, you will be able to practically write your own ticket.

This why the property reps are trying to fend off "bad news" and make the rest of us believe the market is still strong and OK etc. They know in their hearts this is just the beginning of slide not seen in a long while.  

So to all the cheerleaders out there, most likely on the bldg representation side, if you wish to continue making money and that applies to your landlords as well, its time to begin dealing in reality and advising your owners to be ready to deal. It will serve them no purpose to continue to be stubborn because of the unfounded belief this DC Metro Market is immune to negative influences. Even New York is fighting the tide and losing.  

What all you cheerleaders are doing is continuing the disconnect between buyers and sellers and tenants and landlords. This time around time does favor the buyers and tenants, not the other way around.