The Next Bubble to Burst: Commercial Real Estate

While residential borrowing has taken much of the blame for an overinflated market, commercial property mortgages throughout the 2000’s were similarly purchased at the market’s peak. With over 90% of transactions financed through credit, the implosion of the commercial real estate market was inevitable. Commercial properties encompass a huge range of buildings in developed and developing markets, high rise office conglomerates, condominiums, and shopping malls. Major projects have lost tenants to the global financial crisis, triggering decreases in rents and property values, making property owners more likely to default on their debt. As consumers lose housing equity, this impending train wreck has widespread consequences for architects, contractors, interior designers, agents and insurers, to name a few. Real estate entrepreneurs and tycoons fear losses in the trillions.

New York City, at the eye of the storm, was the first to feel the wrath of economic meltdown. In 2008, the value of Manhattan office building transactions declined by over 70%. Major real estate entrepreneurs were forced to deleverage because they could not secure financing and meet loan obligations to their creditors.   Now Shanghai, Tokyo, Berlin and London are all feeling the squeeze.  The implosion is putting further pressure on an already fragile global banking and credit system.

What strange and evil forces are behind this economic catastrophe? Frozen credit flows and rising unemployment seem to be the self-reinforcing culprits. Limited access to credits means property owners cannot meet loan payments or refinance, forcing deleveraging, which in turn further decreases commercial property values. Rising unemployment destroys consumer demand, so retail outlets across the globe are emptied, cutting off cash flow at major shopping complexes and small boutiques alike.  This means that even where credit is available, through government funded injections of capital into the banking system, businesses lack the capacity to service those loans. The result is a spiraling meltdown in which real estate becomes vacant without new buyers or tenants, further distressing revenues.

Companies like General Electric Capital, which earned over $1.1 billion in profits in 2008 alone, may not earn another cent until 2014. As old leases are renewed, GE is forced to lock in lower rates to fill vacant spaces and protect from further losses. Long after the commercial real estate market stabilizes and rents begin to rise, GE will be stuck with current contracts and low rates on office buildings for 5 to 10 years. On the flip side, this unmitigated disaster has opened up opportunities for small businesses to cut costs. For growing enterprises, rent can be one of a firm’s highest fixed costs. Now is the time for renters do some research on vacancies, relocate, or negotiate a better deal. This is just a small silver lining in a storm that is far from over.