by Katie Kuehner-Hebert
The weak economy has hammered many of the mom-and-pop stores that rent commercial space from Robert Phillips, whose company owns and manages property in San Diego. In some cases he has helped them through tough times by offering them as much as four free months of rent.
“The retail sector especially is really struggling, so everybody’s looking for help,” says Phillips, president and chief executive officer of Pacific Coast Commercial Asset Management.
The worst recession in decades has caused apartment landlords and other commercial property owners across the country to contend with falling rental rates and rising vacancies. They are under pressure as jobless renters buddy up and commercial tenants struggle to keep afloat. Business bankruptcies soared in the United States in 2009, and they were on track to double compared to 2008.
Owners are watching the values of their properties tank, in some cases to far below the amount they still owe. Smaller and medium-size property owners are especially vulnerable, but the big and powerful aren't immune either. In New York, developer Tishman Speyer defaulted on debt from its $5.4 billion buyout of Peter Cooper Village and Stuyvesant Town, which was the largest single-property transaction in history. The developer has lost an estimated $3 billion on the deal.
The pressure on property owners is taking a heavy toll. About 2.8 million properties were foreclosed in 2009, up 21 percent from 2008 and 120 percent from 2009, according to RealtyTrac, on online marketplace for foreclosed properties.
“This is not a good time to be an owner of a commercial property—not only has the price of the building likely gone down causing the possibility of an underwater mortgage, but tenants have been able to extract some pretty serious concessions, including free rent in some cases,” says Christopher Cornell, an economist at Moody’s Economy.com, a division of Moody's.
Moody's says its REAL Commercial Property Price Index declined by 44 percent from its peak in October 2007 to the latest reading, which was in October. That means that many owners of commercial properties of all types—office, retail, industrial, warehouse, and apartments—likely now have negative equity in their properties, Cornell said.
The problem is compounded by higher vacancies caused by business tenants going under or apartment renters sharing units to make ends meet, which has resulted in lower rental rates, said Andres Carbacho-Burgos, another economist at Moody’s Economy.com.
Apartments rates fell 4.1 percent on a national basis, and rates dropped much more in some markets, according to George Ratiu, an economist with the National Association of Realtors. For example, rates in and around New York fell as much as 15 percent in some neighborhoods, after the region was hard-hit by massive job losses on Wall Street, which reverberated through the local economy. (For a graphic showing recent vacancy rates in key U.S. cities for office, industrial, retail, and multifamily units, click here).
In San Diego, for example, rents fell by an average of 3 percent, but some parts of the region were hit much harder, says Chris Garland, an account manager with ENG Properties, which owns about a dozen apartment complexes in the area. In neighborhoods that are saturated with apartments, such as the North Park neighborhood, higher vacancies have caused rental rates to fall by as much as 10 percent over the past year.
To attract tenants for its properties, ENG Properties has had to make a number of concessions beyond lower rents. It has reduced security deposits, upgraded appliances, and replaced carpets earlier than the company had planned, Garland says. The company says its efforts have helped minimize vacancy rates at its properties. “We’re not thriving, but we’re doing better than just surviving."
Those owners of just one or two properties with few units are likely suffering the most, says Linda Morris, president ofCambridge Management Group, Inc. in Escondido near San Diego. Morris owns a duplex in San Diego and manages apartments for other landlords.
“Owners of smaller properties have very low margins, and some are having to contribute their own money to pay the mortgages because rents are reduced while operating costs for things like insurance, water, utilities, and trash keep going up,” Morris says.
Owners of larger apartment complexes likely have the cushion of better margins, she says, but then again, many of those properties were bought right before home values plummeted and now their owners are saddled with underwater mortgages.
Garland says ENG Properties has been able to escape that dilemma because it purchased its properties years before the housing crisis. In fact, its properties are now valued higher than before because of all the upgrades the company made last year. ENG Properties says it will likely reap an even better return when it eventually sells those properties.
Phillips, of Pacific Coast Commercial, owns several units within a commercial strip mall in San Diego and manages commercial properties for other property owners. Some of his business tenants asked for discounted rents over the past year, but after reviewing their financial statements, Phillips declined. “I think they were just probing to see what they could get, but they are all doing okay,” he says.
Phillips has heavily discounted rents for tenants of properties he manages for other owners and, in some cases, has given four months of free rent. In each case, the landlords approved the discounts.
In some areas of San Diego, such as El Cajon, rent on industrial space fell from $1.10 to 65 cents per square foot in the span of one year, and many tenants have been looking for a way out of their leases. In cases where tenants are nearing the end of their multiyear agreements, Phillips has been offering lower rental rates as an inducement to renew.
A veteran of several downturns over the past 30-odd years, Phillips says that he believes that property owners have really “matured,” and that most have quickly responded to the current crisis.
“It’s really a partnership between the owners and tenants,” he says. “If the owners are honest with themselves and the tenants are honest with themselves, then they can work together and they can both make it through the cycle.”