How Long Can You Hold Your Breath?

Commercial Real Estate income lags the larger economy. The lag has been seen with each prior recession and all evidence suggests a continuation of this trend. The challenge for participants is to quantify the impact of this recession on the depth and duration of price reductions. Lack of agreement between buyers and sellers on pricing has contributed to a sharp drop in transaction volume. To remove the log jam, the job of the Researcher is to explain the boundaries of likely scenarios. In this short piece, I describe the possible drop in pricing based upon plausible declines in occupancy and rental rates. These assumptions lead to a prediction of office property income reducing by 38% with the decline lasting into 2011. Combine this with an increase in the cap rate from 7% to 10% and

we are facing a value decline of nearly 60% by the end of 2010.

The table below breaks it down in a gross oversimplification.

Sources: 2007 Cap Rate: Real Capital Analytics, 2007 Rent: CoStar Group, 2007 Occupancy: NCREIF

So what do you do if you are an owner, tenant, broker, lender, or other interested party? Where can you make money, or at least lose less money, considering this prediction? The answer varies by your current position and long term strategies. However, the key is to think long term. There are few, if any, low-moderate risk strategies which will be profitable in the short-term. Future editions of this newsletter will explore possible strategies for market participants. However, before I progress too far, let's explore the assumptions which lead to these predictions.