From Manhattan office towers to Florida apartment buildings to retail properties in Washington, commercial real estate values are rising, defying predictions made as recently as February 2010 of a collapse that would drag the U.S. economy back into recession. Prices of commercial properties sold by institutional investors surged 19 percent in 2010, the second-biggest gain on record, according to an index developed by the MIT Center for Real Estate.
Near-record-low interest rates mean buyers can get cheap financing, which improves their returns. At the same time, rising earnings give banks a cushion to absorb losses, enabling them to sell distressed properties rather than hang on to them. Investors, convinced the worst is over, have pushed prices on bonds backed by commercial mortgages to the highest level in two years. Says Dan Fasulo, managing director at New York-based Real Capital Analytics: "Now that values are on the upswing, it's given owners and lenders more wiggle room to work out these troubled situations."
Those taking advantage of improving conditions include Vornado Realty Trust (vno.), which in December resolved a standoff with its lender by paying $115 million to buy the $171.5 million loan on its Springfield Mall in a Virginia suburb of Washington. The loan had been transferred to a special servicer a year earlier because the New York-based real estate investment trust was in danger of "imminent default" on the property, according to Fitch Ratings.
In downtown Fort Lauderdale, a market damaged by declining home values, USAA Real Estate bought Las Olas Centre, a 469,000-square-foot office complex that had been seized by lender Wells Fargo (wfc.). USAA Real Estate, based in San Antonio, paid $170 million in September; the previous owner spent $231 million near the top of the market in July 2007, according to Real Capital.
In February 2010, the Congressional Oversight Panel of the Troubled Asset Relief Program warned that a deteriorating commercial real estate market had the potential to wreck the U.S. economy. It estimated that almost half the $1.4 trillion in commercial property loans set to be paid off by 2014 were underwater, meaning the borrower owed more than the property was worth. Unless refinanced, the debt "could threaten America's already weakened financial system," the panel said in a report.
New York, Washington, and Boston are among the cities leading the recovery as employment growth and large inventories of properties with a lot of rent-paying tenants attract investors.
Market segments including hotels, apartments, and retail are also on the rise. A hotel rebound started last year, with the average occupancy rate in the top 25 U.S. markets rising to 64 percent from 60 percent in 2009, according to Smith Travel Research in Hendersonville, Tenn. Sales of apartment buildings nationwide rose in the fourth quarter as homeownership remained at a 10-year low and demand for rentals pushed lease rates to the highest in four years, according to Axiometrics, a Dallas-based research company. Of the $52 billion of retail properties to fall into default, just over half have completed workouts, "giving the retail sector the distinction as the first property type to pass the halfway point in resolving its distress," Real Capital analysts wrote in a January report.
"That tsunami of distress that had been forecast has not really materialized," says Brian Stoffers, co-president of CBRE Capital Markets, a financing and investment sales division of Los Angeles-based broker CB Richard Ellis Group. "The market's getting stronger."
The bottom line: More than half of defaulted properties have completed workouts, helping to prevent disaster in the commercial real estate market.