RECOVERY IN COMMERCIAL REAL ESTATE – WANTING FOR JOBS

As I noted in my last post, consumer confidence continues to lag due in part to the weak job
picture. Little has changed over the last month. The recent employment headline that showed
431,000 jobs created in May includes 411,000 temporary hires by the Census. The back story
is that the private sector created a mere 41,000 jobs in May (after adding 218,000 in April).

For me, our economic engine is fueled by new jobs – and today, our recovery is wanting for
notable and stable job growth. It is difficult to compare past downturn / recovery cycles with
today’s because our economy has become so much more complicated. It is interesting to note
that in the last several days a handful of news articles have commented on the risk of a double
dip recession – which is not unlike the commentary that surrounded the tech bust and recovery
during 2000 to 2003. While I do not believe we will see a double dip, I do think that the recovery
will be treacherously slow, impacting private sector job production and reverberating through
consumer confidence for a long while to come.

This past week, Fitch released its year-end 2009 report on CMBS loss severity. Among the top
headlines were that the inventory of CMBS loans in special servicing was at an all-time high and
that loss severities reached 57% in 2009, which represented a 43% increase from 2008. These
stats are for the handful of
loans that have already Loss Loan Original Current
Property Type Severity Count Balance Delinquency
turned bad and are beyond Multifamily 58% 78 $402 million 13.7%
repair. Retail 48% 61 $291 million 6.0%
Office 57% 30 $150 million 4.6%
Industrial 49% 17 $77 million 5.1%
I think the more important Hotel 82% 7 $76 million 18.6%
conclusion in Fitch’s report,
however, was that special TOTAL / Average 1/ 57% 202 $1,065 million 8.0%
‘1/ Includes other property types.
servicers will continue to see
high volumes of under- Source: Fitch Ratings; Walter S. Bialas.
performing loans and the
declining frequency of modification suggests that no relief is in sight. This conclusion is
bolstered by Fitch’s reported 49-basis point increase in delinquency rates.

CoStar identified in their first quarter national report that office vacancy increased to 12.8%, a
slight increase from year-end. While space deliveries have slowed, net absorption continued to
run a negative-3.4 million square feet for the 140 metro markets they track.

Although second quarter data are not yet available at the national level, it is instructive to look at
how one of the more robust employment markets is rebounding. At the end of first quarter, the
Washington, DC region had total office vacancy of 13.4% and positive net absorption of 170,000
square feet. Currently through the second quarter, office vacancy has been roughly stable at
13.3%, with 970,000 square feet of positive net absorption. Unfortunately, with 2.3 million
square feet delivered and almost 5.0 million square feet under construction, the market is very
competitive. In fact, CoStar reports that more than 1,700 office buildings (covering 82 million
square feet) in the DC region have occupancy below 80% – and that 35-plus million square feet
of office space has been on the market for more than 22 months (see graph below).
Given DC’s economic health and level of stimulus dollars, this level of office space competition
will weigh on the sector and delay a local property recovery.

More to the point, though, the majority of other markets in the US are seeing much less vibrant
employment dynamics. With that said, the lack of a broader private sector job rebound will
continue to impact most office markets – and carry over into the other property sectors. While
Fitch sees property stress continuing from a rating agency perspective, the core issue for me is
that many properties will fly under the radar and be challenged by lower than “stabilized”
occupancy and rents – across all the property types.

Walter Bialas has more than 25 years of real estate advisory experience in consulting, banking and development.
Walter currently serves as chair of ICSC’s North American Research Task Force and is an active member of ULI’s
Advisory Services program. He can be reached at 703-919-8553 or by email at wbialas@verizon.net.

June 2010