The Deal Pipeline in 2011: Is the Pig Finally Moving Through the Python?

It’s Spring; maybe the scent of flowers in the breeze causes daydreams of recovery, but after the long freeze in commercial real estate activity, there are some signs of a thaw.  Not all the news is good, but like the first trickles of water after a hard winter, there are signs of improvement.   As you may have heard at GlobeSt.com’s recent Real Estate 2011 conference in Los Angeles, or by browsing the posted presentation videos, it’s starting to sound like lenders and servicers are finally selling off and resolving some of their troubled loans – the ice around “extend and pretend” is starting to crack. 

Some early indications that the “major food groups” of real estate markets are bottoming out of even improving is welcome.   Risks abound, of course.  Another economic shock, from the likes of higher sustained oil prices, potential shutdown of the federal government, or similar problems in Europe, might yet derail the fragile economic recovery.  Still, in the spirit of Spring, here is a rundown of some good news and mixed news, suggesting at least that some things are beginning to move in commercial real estate.

First of all, hotels – the first real estate food group hammered in the great recession – appear finally to be stabilizing:   

HotelNewsNow.com says that the U.S. hotel industry reported strong increases in all three key performance metrics during the week of 27 March-2 April 2011, according to data from Smith Travel Research. 

• The weekly results were boosted by softer year-over-year comparisons. Easter, a historically low travel weekend for hotels, was on 4 April 2010.
• Overall, the U.S. hotel industry’s occupancy was up 12.2% to 60.8%, its average daily rate increased 5.3% to US$100.18, and its revenue per available room finished the week up 18.1% to US$60.91.
• Among the chain-scale segments, the upper-upscale segment rose 18.1% in occupancy to 71.2%, reporting the largest increase in that metric, followed by the upper-midscale segment (+15.4% to 61.7%) and the luxury segment (+15.2% to 73.5%).
• The upper-upscale segment reported the largest ADR increase, rising 9.9% to US$148.31.
• Three chain-scale segments experienced RevPAR increases of 20% or more: the upper-upscale segment (+29.9% to US$105.54); the upscale segment (+20.4% to US$78.03); and the upper-midscale segment (+20.0% to US$56.93).

The office market also is starting to recover, according to a report from Reis Inc.: 

• Office vacancies in the U.S. dropped for the first time in more than three years in the most recent quarter and rents climbed, signaling the market is beginning a recovery as the economy improves.
• The national vacancy rate fell to 17.5 percent in the first quarter from 17.6 percent in the previous three months, Reis Inc. said in a report today. The drop was the first since July through September of 2007. Asking and effective rents rose for the second straight quarter after more than two years of declines, the New York-based property-research firm said.  

This drop in vacancies appears to be tied to growth, albeit slow growth, in employment.  The early upticks seem to be working their way slowly westward, after starting on the East Coast.  That trend has not necessarily improved the California market yet, as indicated by reports this week that two major downtown LA office buildings have just gone into special servicing.

House prices, on the other hand still seem to be going down nationally.  While that may have slowed, obviously it’s still not yet a good sign for retail:  folks don’t shop as much when they feel their major assets are declining in value.  According to the CoreLogic HPI, national home prices, including distressed sales, declined by 6.7 percent in February 2011 compared to February 2010 after declining by 5.5 percent in January 2011 compared to January 2010.  This means that house prices have been going down for seven straight months. 

Excluding distressed sales, year-over-year prices declined by 0.1 percent in February 2011 compared to February 2010 and by 1.4 percent in January 2011 compared to January 2010. Distressed sales include short sales and real estate owned (REO) transactions.    In evaluating this data, I don’t think it makes sense to exclude distressed sales from any analysis of the housing market, but that’s how this particular index, which is not seasonally adjusted, works.

Not surprisingly, with house prices still declining, vacancies at US regional malls have risen to their highest level in at least a decade according to Reis Inc.  Bloomberg reported that landlords are struggling to keep tenants in place and occupancy rates up after the recession:   

• The vacancy rate climbed to 9.1 percent from 8.9 percent a year earlier and 8.7 percent in the fourth quarter, the New York-based research firm said in a report today. It was the highest since Reis began publishing data on regional malls in the beginning of 2000.
• An eight-month rise in U.S. retail sales has failed to spur increased mall occupancy, partly because of the amount of time it takes to structure long-term leases, said Victor Calanog, chief economist at Reis. The bankruptcy of Borders Group Inc., the second-biggest U.S. bookstore chain, and closings by Macy’s Inc., the No. 2 department store, also contributed to the vacancies, he said.
• “We should see some improvement in the retail sector sometime later this year or early next year,” Calanog said in an interview. “A reasonable estimate of when healthier sales will translate into rising demand for retail space is around nine to 12 months.”

The macroeconomic drag on retail from a weak 2010 compounded the pain already caused by structural market change, due to the Internet virtualization of some retail sectors like booksellers (think of the Borders bankruptcy) and video rental stores (think Blockbuster).  We should be comforted to note that, at least in this decade, fresh coffee & donuts, and muffler & oil changes, are delivered from storefronts and retail pads, not via the Internet.  You can’t get your morning latte and cruller by Twitter, just yet.  Further, the LA Times just reported on April 8 that retail sales in March rose by 1.7% year-over-year, better than the 0.7% decline that had been expected, according to Thomson Reuters’ tally of 25 major retail chains.  Of course, rising prices for gas, cotton and overseas labor might quell these improvements to retail sales.

So, to summarize, there are some early signs of upticks in hotels and office space, but a continued weakness in housing prices which may keep storefront retail down and in oversupply for a while.  If our government folks can make some progress in housing & employment, and thus household disposable income, we should see some of that come back to us as a shot in the arm to retail.  Is it a false Spring, too early to hold out hope?  Or are you starting to see a few rays of recovery sunshine?