Scotsman Guide - June 2010 Commercial Edition

Property TypeCast
By Victor Calanog

DIRECTOR OF RESEARCH, REIS INC.

rEtail rEcovEry dEpEnds on laBor markEts

Retail properties experienced unprecedented distress throughout 2009. A silver lining? Occupied stock declined by 3. 5 million square feet in the fourth quarter of ’09, representing a lower level of loss compared to the first three quarters of the year.

Although this is less of a bloodbath than the first half, note that throughout ’09, loss of occupied space exceeded the amount of new completions. This implies that existing properties were vacated faster than new properties added occupied stock. Thus, retail landlords faced a losing battle throughout ’09 in finding new tenants and holding onto existing ones. Vacancies hit 10. 6 percent in the fourth quarter of the year, the largest level on record since 1992.

Rent deterioration followed suit. Asking and effective rents continued to decline for midsize retail properties as landlords faced tenants who were downsizing space requirements, negotiating more-favorable lease terms or simply going out of business. Effective rents decreased by 3. 7 percent throughout ’09 for these properties, the largest decline on record since Reis began tracking neigh-borhood- and community-center-performance data in 1980.

RETAIL NET ABSORPTION AND VACANCy RATES

Larger malls did not escape unscathed. Vacancies increased by 20 basis points for these properties between the third and fourth quarters of ’09 to hit 8. 8 percent — another record since Reis began tracking this rate in ’00.

Asking rents decreased by 0.4 percent in the fourth quarter. This marks a five-quarter rent decline — the first in almost 10 years of quarterly history. The 3.6-percent year-to-year decline also is the largest on record.

Source: Reis Inc.

These national figures appear evenly distributed, with distress affecting most geographic markets.

The vacancy rate for neighborhood and community centers increased in 52 of the 77 largest metropolitan areas; effective rents fell in all 77. This is the first time there has been such a uniform distribution of distress in Reis’ 29-year history of tracking these properties. 12-MONTH CHANGE IN RETAIL SALES

Economic pressures likely will continue to weigh on consumers and businesses, with continuing high unemployment affecting retail properties for at least another 18 months. Although retail sales posted recent signs of growth, consider how bad things were in ’09: Retail sales declined 6.2 percent throughout the year, the steepest annual decline since the Department of Commerce began tracking the data in ’92. Sales slipped a mere 0.5 percent the previous year.

Source: Reis Inc.

Even as the economy grows, sector by sector, expect neighborhood and community centers to experience increasing vacancy levels and negative asking- and effective-rent growth through next year. The deterioration in asking rents through ’09 encompasses some of the greatest reductions on record. It is no longer just a matter of landlords offering concessions and tenant improvements, which would lower effective rents. Landlords are now in a fierce battle to attract or retain tenants by lowering their initial asking prices.

Only when labor markets can muster a sustained recovery can we expect asking rents to increase and vacancies to decline.

Victor Calanog, director of research at Reis Inc., writes a monthly column on property types for Scotsman Guide. As head of Reis’ core economics team, he is responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com.

QA&

Carol Galante DEPUT Y ASSISTANT SECRETARY FOR MULTIFAMILY HOUSING PROGRAMS U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

BY DARRICK MENEKEN

As head of multifamily programs for the U.S. Department of Housing and Urban Development (HUD), Carol Galante oversees a portfolio worth more than $60 billion. We asked her about planned changes to HUD’s multifamily programs and what they mean for the commercial mortgage industry.

HUD has proposed tighter underwriting stand-
ards for multifamily construction and refi-
nancing. Why?

We think it’s critically important that our underwriting standards are modernized, assess risk appropriately and ensure these properties are successful.

Why not increase insurance premiums?

There are a number of ways to address risk. We felt making these fundamental under writing changes is a better way to do that over the long term. It keeps the borrowing costs down so properties that meet these underwriting guidelines can still access financing at an attractive rate.

Are you worried about FHA’s reserves?

We’re always concerned about ensuring the long-term solvency of the fund. It’s fundamental to what we do that we protect the goose that lays the golden egg. We think these underwriting changes are prudent and will ensure that we don’t have to be overly concerned about our position in the market.

As of press time, the changes weren’t pub-
lished. What timeline are you considering?

I would say they would be published by early summer. Most of the underwriting changes are policy changes that can be done through mortgagee letters, as more of a notification. A few things require regulation changes, which will take longer.

Will the changes take effect before the end
of the year?

I don’t think they will. We want to ensure the industry has some time to adjust. People often work on multifamily developments — getting them approved through their local city councils and putting financing packages together — for months before they submit them to us for financing.

Do these changes reflect a decision by FHA
to lessen its role in the multifamily market?

Absolutely not. During the first six months of fiscal year 2010, we almost equaled our total production under the (Section No.) 221(d)( 4) program for all of last year. So we aren’t slowing down. We think there’s plenty of good product that can meet these under writing criteria, and we’re going to continue to be available in the marketplace. I don’t see that a lot of deals are going to fall through. I think people will find a way to come up with a little more equity, which is, bottom line, what they’re going to need to do.