You thought the downturn in home prices was bad. But just wait until you see what happens to commercial real estate in 2009.
Another speculative bubble is bursting, and this time the foreclosures won’t be claiming triple-deckers in Dorchester and Roxbury, but rather some of the towers that light up Boston’s bejeweled skyline at night.
That’s one of the predictions Joe Sciolla, managing principal at CresaPartners, is making in his recently released forecast for 2009. And it’s likely to be painful reading for Hub commercial real estate executives, who have managed so far to escape the worst of the recession.
Sciolla, who has built a reputation as the contrarian of the local office market, predicts double digit drops in rents, a big rise in vacant office space, and some serious trouble for the investors who bought much of the city’s skyline during the boom. In fact, before it’s all over, some tower owners may be forced to turn over the keys to their sky-rises back to their banks.
When I last interviewed Sciolla, it was in September, right after the global financial crisis erupted in full force. He was then predicting trouble ahead for the still-strong-on-paper office market, but some of his colleagues in the commercial real estate business were dismissing such views as alarmist.
After all, while few firms were actually still in the market looking for additional office space, the number of empty office suites was low and rents were still high.
What a difference a few months – and a fair amount of economic history – can make.
If nothing else, Sciolla’s forecasts make for more scintillating reading than the typical, hedge-your-bets forecast by a downtown commercial brokerage firm.
“We are undergoing an inevitable market correction following the artificially inflated rents at the economy’s peak—and the markets with the biggest bubble, including metro centers like Boston, will likely take the biggest tumble,” Sciolla writes in his forecast.
In Sciolla’s view, there are more than a few similarities between the housing market crash and the nasty storm that appears to be brewing in the office market.
Like too many homeowners, hedge funds and other aggressive real estate investors took advantage of cheap debt during the boom to snap up icons like the Hancock Tower at stratospheric prices.
And like more than a few homeowners now facing foreclosure, these investors piled high the debt to buy assets they really couldn’t afford, confident of flipping for even more immense profits a few years down the road.
We all know what happened to home sales. Values began to plunge, cutting off the escape route for all those homeowners and real estate speculators who had banked on flipping for some big profits.
On a vast scale, real estate investors, such as New York-based Broadway Partners, which plunked down a stunning $3.3 billion to buy the Hancock tower and nearby office buildings, made a similar fundamental miscalculation.
“It’s the same thing that drove the residential market,” Sciolla said. “The debt was cheap. There was an artificial inflation of values.”
But the once booming office market on which all those optimistic assumptions were built began to weaken late last year. And, in the three months since the global financial markets erupted, the trend lines in the local office market have gone from bad to worse.
Rents for top shelf tower space have already dropped 20 percent in downtown Boston, bringing them back down to the $55-a-square-foot range. And Sciolla sees another 20 percent plunge in rents ahead over the next 18 months, one that could bring Class A rents down to the $45-a-square-foot range.
Meanwhile, the amount of empty office space is likely to rise into the double digits over the next year as Fidelity Investments, Bank of America and other downtown employers push ahead with plans to slash their payrolls.
Left holding the bag will be those firms who bought into the office market at the peak, such as Broadway Partners. The New York investment firm is faced with the need to replace a key part of its Hancock financing package early next year, in a market where the number of lenders willing to entertain such deals has dwindled dramatically.
“It’s just the start of the bursting of the commercial real estate bubble,” Sciolla said. “You are going to see foreclosures and some of these buildings going back to their lenders.”
“Some are already under water,” he added.
But like the housing market, the fall in values on the commercial side could have a silver lining for some.
Developers are already snapping up foreclosed homes at rock bottom prices.
In the office market, Sciolla’s specialty is representing companies looking for new space.
And for those firms fortunate enough to have solid bottom lines, there is no better time to negotiate a deal.
In fact, some tower owners will entertain giving away up to a year’s worth in free rent in exchange for a 7-to-10-year lease, he notes.
“In general, we remind tenants that this recession has a silver lining: They now have leverage dealing with landlords who are desperate to maintain their assets and retain credit-worthy tenants,” writes Sciolla in his 2009 forecast.
Tagline: Scott Van Voorhis can be reached at sbvanvoorhis@hotmail.com
