By Thomas A. Corfman
(Crain’s) — In a race to the bottom, Chicago office buildings will continue to lose value over the next year, but other major cities are expected to fare worse, according to a recent investor survey.
Investors predicts Chicago-area office buildings will lose on average 4.39% of their value over the next 12 months, according to the first-quarter Korpacz Real Estate Investor Survey conducted by PricewaterhouseCoopers LLP.
But seven markets, including San Diego, Atlanta and Boston, will see office building values slide even further, according to the report, which surveys investors nationwide.
The quarterly report usually offers a dour view of the Chicago market, and the current survey is no exception.
“Plagued by corporate downsizings and a lack of new leasing activity, pessimism is widespread among investors in the Chicago office market,” the report says. “A main concern now for several landlords is the flurry of mostly short-term renewal leases, and the inability to secure long-term deals.”
One sign of how local prices have already fallen is capitalization rates, which rise when prices fall. The average Chicago-area cap rate, or first-year return, rose to 7.70% in the first quarter of 2009, compared to 7.00% during the same period in 2008, the report says.
The report forecasts changes in values, but does not track historical changes. However, based on current average cap rates, the Chicago area currently ranks 12th among the 18 markets nationwide that the report tracks.
All the ingredients for a sharp decline in the value of local office properties are present: a tight market for large commercial real estate loans, weakening leasing and skittish equity investors.
“Put all that in a blender and then spit it out, (the value decline) is probably a lot greater than what we want to admit,” says Paul Lundstedt, a Chicago-based senior vice-president in the capital markets group of Grubb & Ellis Co.
But the scarcity of major office building sales locally since January 2008 makes any estimate of the decline impossible, he says.
“When investment activity comes back, it’s going to come back aggressively,” he says.
The Korpacz report says that notwithstanding the widespread belief that distressed-asset sales will rise in Chicago this year, deals are still very difficult to do.
“Even though all-cash buyers have an advantage over leveraged buyers, a lack of recent sales data is making it difficult for all types of buyers, and even sellers, to estimate value,” the report says.
Despite the dismal forecast for Chicago, the local market might still “outperform” the national office market, where office property values are predicted to fall on average 5.9% in central business districts and 9.44% in the suburbs.
A year ago, Chicago was the only market where office building values were expected to drop.
Related story: Investors forecast dip in local office values
Now, seven markets are expected to see steeper declines than Chicago, led by San Diego, where prices are forecast to fall 15.0% over the next 12 months.
The report, which focuses on the office market, also sees reason for concern about the Chicago industrial market, which ranked third nationwide in 2008 construction activity, with 17 million square feet. The only markets with more construction were the Inland Empire, east of Los Angeles, and Dallas/Fort Worth.
“A decline in the consumption of goods on behalf of consumers has led to job losses in the U.S. manufacturing sector and a decline in demand for warehouse space,” the report says.
The commercial real estate sector lags the general economy, and many observers say the full effect of the recession won’t be felt, particularly in the office market, for some time, even if the economy starts to pick up later this year.
On a national basis, the report says:
• In 2010, the apartment rental market will begin to recover, the report says. “Even though the multi-family market is benefiting from the credit crunch by forcing more individuals to rent housing than buy it, the rising number of foreclosed homes and unsold condominiums has increased competition.”
• In 2011, the retail market will begin to recover. “As consumers rein in spending amid the national economic recession, the retail sector is combating declining retail sales, rising vacancy rates, and growing store closures.”
• In 2012, the industrial market will rebound after a “dynamic shift.” In the meantime, “with fewer goods being demanded by consumers, the number of both U.S. imports and exports has declined.”
• Also in 2012, the office market will begin to recover. “As unemployment figures rise and more companies return space to the market, vacancy rates are likely to continue to increase throughout this sector in the year ahead.” Conditions in the office sector will worsen in 2010.
Copyright © 2009 Crain Communications, Inc.
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