A stressed global economy means no easy deals for practitioners.

Since commercial property performance usually tracks economic conditions, it will come as no surprise that 2009 looks like a challenging year for commercial real estate owners, brokers, and managers. 

"The weak economy has shifted the fundamentals in commercial real estate," says NATIONAL ASSOCIATION OF REALTORS® Chief Economist Lawrence Yun.

Office, industrial, and especially retail can expect rising vacancies, stagnant or falling rent growth, and flattening cap rates. Even multifamily, which you might expect would benefit from tumbling residential sales, will just hold its own. Rents will stagnate at around 3 percent in 2009 and absorption will not keep pace with even the slowing level of new product coming online. 

"For now, at least, more people are doubling up or moving back home rather than renting," notes Yun. 

Housing Must Lead the Way Out

If commercial's nose dive grew out of the fall in residential home sales and the ensuing financial meltdown, recovery for commercial sectors will likewise depend in large part on housing's recovery, says Yun. Housing typically leads the economic recovery, so when home prices firm up, the economy will start expanding. Increasingly confident households will renew spending, and businesses will ramp up hiring. 

"We need to jump start this virtuous cycle," says Yun.  But whether this recovery will come in 2009 is still questionable.

Housing's recovery still rests, in large part, on the availability of credit. Credit started to loosen in late 2008, thanks in part to the massive injection of federal funds into financial services companies in September and the Fed's decision in late November to purchase mortgage-backed securities. But it will take considerable time before credit availability returns to normal.  

NAR has been calling for an additional stimulus—interest-rate buydowns and help for troubled borrowers—to provide the economic boost that can get sales rolling again. (See our residential market outlook.)

"Only by getting buyers back into the marketplace will there be home price stabilization," says Yun. "And only then will mortgage-backed securities start trading on Wall Street again, helping to thaw out the frozen credit market."

The good news for commercial borrowers is that commercial mortgage-backed securities may come back fast once credit eases because investors won't have the same trouble pricing assets that they've had in the residential sector, says Doug Duncan, chief economist for Fannie Mae.  

"Because the ratings of CMBS are based more on individual property performance, there's a greater likelihood that these securities will produce the returns anticipated," Duncan says.

If credit does ease by mid-2009, it won't come a moment too soon for the many commercial property owners whose loans are due to roll over in 2009.  Bob Bach, chief economist of commercial brokerage giant Grubb & Ellis, said in an Investment News report that close to $40 billion in commercial debt is set to expire in 2009. 

A good portion of lenders will balk at refinancing this debt because of falling commercial property prices and tighter lending standards. That means that some properties will be sold at severely reduced prices. Retail and office properties will be hardest hit, he says. Cash-rich buyers, especially those from offshore, might find the biggest commercial property bargains since the early 1990s.

For owners who don't have to sell, sitting tight and managing for better cash flow remains the best strategy for 2009.  That's why transaction volumes, which declined by 70 percent between the second quarter of 2007 and the second quarter of  2008, will almost certainly fall further in 2009. 

Commercial real estate prices could fall by 15 percent to 20 percent from mid-2007 highs, according to the 2009 Emerging Trends in Real Estate, developed by the Urban Land Institute and PricewaterhouseCoopers.

But 2010 should be much better. Yun is forecasting a U.S. economic recovery in 2010, which should help drive up prices, rent growth, transactions, absorptions, and investment returns. 

The big question is the health of other economies. If they're not growing too, the demand for U.S. assets and asset-backed securities will remain dampened, which could soften financing availability for commercial property.

NAR's Projections for 2009

OFFICE

Job losses, especially in the professional business sector that uses much of the country's office space, are reducing the demand for office space. In the last four recessions, job losses continued an average of 17 months after the employment peak, says Mark G. Dotzour, chief economist at the Real Estate Center at Texas A&M University. If that benchmark holds true, employment should pick up by May 2009, he says. 

• Office vacancy rates are projected to rise to 14.4 percent in the second quarter of 2009 from 12.9 percent in the second quarter of this year. Annual rent growth in the office sector is likely to be 3.2 percent this year, but it should decline to 0.4 percent in 2009. 
• Rent grew 8 percent last year. 
• Net absorption of office space in the 57 markets tracked, which includes the leasing of new space coming on the market as well as space in existing properties, is expected to be 14.7 million square feet in 2008 and 10.9 million in 2009, contrasted with 57.3 million square feet in 2007. An increase in the amount of new office space coming online in 2009 contributes to this significant drop. 

INDUSTRIAL

Healthy exports had been one of the bright spots in the U.S. economy in 2008, but uncertainty in world economies and a recovering dollar could weaken overseas demand. Still, American goods remain attractive to overseas buyers so warehouse space should remain relatively stable, especially in coastal ports. 

• Vacancy rates in the industrial sector are forecast to rise to 10.8 percent in the second quarter of 2009 from 9.9 percent in the second quarter of 2008. 
• Annual rent growth will probably be 1.1 percent in 2008 and 1.0 percent in 2009. It rose 3.6 percent in 2007. 
• Net absorption of industrial space will be a negative 16.7 million square feet in 2008, then reversing to grow to 35.3 million in 2009. Net absorption totaled 120.3 million in 2007.  Developers may find some business in build-to-suit properties, leaving many obsolete structures unoccupied.

RETAIL

Consumer spending, already falling to levels unseen since the 2001 attacks, will continue to tighten for the foreseeable future.  

• Vacancy rates in the retail sector should be 10.4 percent in the second quarter of 2009, up from 9.7 percent in the second quarter of 2008. Average retail rent is projected to grow 1.2 percent in 2008 before contracting 0.9 percent in 2009. 
• Retail rents grew 3.2 percent in 2007. 
• Net absorption of retail space in 53 tracked markets is likely to shrink by 2.6 million square feet this year before increasing by 2.8 million in 2009. In 2007, 11.1 million square feet of retail space were absorbed.

MULTIFAMILY

The outlook for the apartment rental market remains fairly positive as many potential first-time home buyers remain on the sidelines. 

• Multifamily vacancy rates are expected to rise to 5.9 percent in the second quarter of 2009 from 5.4 percent in the second quarter of 2008. 
• Average rent is forecast to grow 3.9 percent in 2008 and 4.0 percent in 2009, compared with a 3.1 percent gain in 2007. 
• Multifamily net absorption is estimated at 61,400 units in 2008 in 59 tracked metro areas and 188,200 in 2009, in contrast with 234,400 in 2007. Unsold condos in many markets may add to the inventories and weaken overall absorption.