Looking for the Bottom

If there was a theme to this year's St. Louis metro market forecast from the Society of Office and Industrial Realtors (SIOR) it was looking for the bottom. There is so much uncertainty in the marketplace that most of the speakers backed off from making forecasts for 2009. The expectations, however, were that commercial real estate markets have not yet hit bottom.

Glenn Guenther of Discovery Group, LLC, described the 2008 as a “schizophrenic year” for the office market. There was brisk activity in the first half of the year and then the market “slipped into a coma” for the last half of the year. Taken as a whole, the office market looked “surprisingly stable and resilient” in 2008 with vacancy rates hitting their lowest levels since 2000, he said, but he doesn’t expect that 2009 will look the same.

The trends Guenther expects to see in 2009 are:
• flat demand for office space,
• a migration of tenants from Class A space to Class B space,
• a growth in short-term lease renewals,
• falling lease rates, and
• limited new construction.

There are, however, some bright spots, he said. The market is not overbuilt and there are very few big blocks of vacant office space available – only five blocks of 50,000 square feet or more. The medical and biotech industries are growing, as are Monsanto, Edward Jones, and Scottrade.

According to J. Patrick Reilly of Gateway Commercial/Cushman & Wakefield, the industrial market also looks better on paper than it really is. Leasing was up in 2008, absorption of new space was steady, and the vacancy rate was only 6.8 percent, but two large deals skewed the statistics, accounting for 27 percent of activity and regional competitors are adding and absorbing more space each year than is St. Louis. Take Illinois out of the equation and the Missouri side of the metro area actually had a negative absorption rate of industrial space, meaning space was taken out of the market.

There has been a paradigm shift in supply chains, he said, and St. Louis is losing the race to connect bulk distribution centers to deep water ports by rail. Craig Meyer, SIOR international president, said the offshoring of manufacturing from the United States has become as big an event as the industrial revolution. Manufactured goods now come to the U.S. by ship – 75 percent of it to the west coast, 25 percent to the east coast. The new distribution paradigm is to transfer cargo containers from ships to trains, which carry them to bulk distribution centers where the containers are transferred to trucks. “Railroads are building bulk distribution centers in Kansas City and Columbus, OH,” Reilly said, but not St. Louis.

“St. Louis is now overbuilt as an industrial market,” Reilly said. Rents are less than the taxes on some buildings, he said, and he looks to see some distressed sales later in the year. He suggested that turning the market around may depend on St. Louis developing a niche as an inland port and getting a direct rail connection to a deep water port such as Houston.

Alan Bornstein of THF Realty Inc., said the 15-year growth cycle in the retail market is over. In each of the last six months there has been a substantial statistical drop in consumer spending, he said. Couple that with the growth of ecommerce and any future real estate deals in the retail market likely will rely on public-private partnerships instead of private financing, he said.

Joe Monteleone of Q10/Triad Capital Advisors Inc. said lenders want more equity in deals – in the retail market they are willing to lend for 60 percent of the value of a deal, he said – and they are concerned about refinancing. He noted that $230 billion of commercial mortgage backed securities are coming due in the next three years and one big question mark is how those owners will refinance.

“Lenders will be conservative for awhile,” he said, but “every recession creates asset buying opportunities.”

Monteleone guessed that, “we’re still trying to find the bottom of the trough,” but added that some positive news is that insurance companies expect to get back into the lending market near the end of 2009.

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