Commercial Real Estate http://www.wikinvest.
com/concept/Commercial_Real_Estate
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Concept
Commercial Real Estate
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This article describes a concept which could impact a variety of companies and industries. The article
lists companies that could benefit or be harmed by the trend. To see what companies and articles
reference this concept page, click here.
Definition: Commercial real estate is defined as Bulls edit Top Contributors
property used solely for business purposes. Office
1. Uptick in Commercial Foreclosures. For the last Adam
buildings, malls, industrial parks, hotels, convenience couple of years the Commercial Property Farren
stores, apartment complexes and gas stations are all market has seen... read more
Sr.
examples of commercial real estate. 2. A Return to Rational Prices. The current credit
Director
crunch has positive effects. Those same
Commercial real estate is distinct from residential real speculative buyers... read more Jay
estate, which has been under the microscope in 2007 3. Flexible Sellers. Sellers know the lenders are Thornton
and 2008 due to the subprime lending crisis. Issues only funding solid deals that are well priced. We
Director
are seeing... read more
related to the failure of mortgage-backed securities
Dike
have driven property values down and created problems Bears edit
Drummond
for both home owners and institutional lenders, and this
1. We are all living through the Residential Real Sr.
has had a rippling effect on other parts of the economy. Estate Meltdown
Associate
The commercial real estate market has suffered from 2. The nastiest Credit Crunch in a very long time.
the fall-out, but it has not bled as deeply as its 3. The Bursting of the Retail Bubble Related Articles
residential cousin. Investors must ask: how far will
Send the authors a comment or suggestion Alexandria
commercial real estate values continue to decline, or
Real Estate
will they eventually plummet in the continued
Equities
aftershocks of the subprime debacle? Or will they
(ARE)
rebound more quickly than home properties and remain
AMB Property
attractive investment opportunities?
(AMB)
AMREP (AXR)
Submit
Bear Stearns
Contents This article has nothing to do [Dismiss]
with the Concept and is just a [Done] Companies
1 Contractors that Build Commercial Properties sales pitch it should be deleted (BSC)
2 REITs an... more
Boston
2.1 Office REITs See All Suggestions Properties
2.2 Hotel/Motel REITs (BXP)
2.3 Industrial REITs
2.4 Retail REITs
3 Other Companies that Develop Commercial
Properties
4 How To Invest in Commercial Real Estate
4.1 Direct Investment in Properties
4.2 Indirect Investment through Real Estate
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Commercial Real Estate http://www.wikinvest.com/concept/Commercial_Real_Estate
Investment Trusts
5 How the Subprime Lending Crisis has Affected
Commercial Real Estate
5.1 Why Commercial Real Estate Will Escape
the Subprime Fallout
5.2 Why Commercial Real Estate Won't Avoid
Subprime Damages
6 Recent Activity in the Office Market
7 References
Contractors that Build Commercial Properties [edit ]
These companies depend on the relative strength of the commercial real estate market to earn new contracts, as well as the
continued financing of their current projects by existing developers.
Fluor Corporation is the largest firm in this market, and offers engineering, procurement, construction management, and
project management services worldwide.
McDermott International is an engineering and construction company worldwide. The company operates in three
segments: Offshore Oil and Gas Construction, Government Operations, and Power Generation Systems.
Foster Wheeler provides construction and engineering services to the oil and gas industry, as well as chemical,
pharmaceutical, and power plant operation sectors.
Perini offers general contracting, construction management, and design-build services to private and public clients.
Granite Construction is a heavy civil contractor, building public works and producing construction materials for public and
private sector clients in the United States.
REITs [edit ]
Real estate investment trusts , or REITS, are corporations or trusts that pool the capital of many investors to purchase income
property (equity REIT) and/or mortgage loans (mortgage REIT). An equity REIT owns and manages property, as opposed to a
mortgage REIT which purchases mortgages and may also borrow money from banks to lend again at higher interest rates.
REITs that invest in commercial real estate can do so through commercial loans, or through the development and ownership
of property. Shares in a REIT are publicly traded on stock exchanges, and these companies are eligible for corporate income
tax exemptions but in return are required to distribute 90% of their income to shareholders as dividends.
REITs are exposed to the volatility of the commercial real estate market in that their revenues will decline if rents and property
values are low, or if costs of development or borrowed capital are too high. However, most REITs have diverse portfolios with
holdings in a variety of economic sectors and geographic regions, helping them to shield them from isolated fluctuations in
the market. Below is a list of commercial REITs, broken down by the sector on which they focus.
Office REITs [edit ]
These REITs focus on the development and/or ownership of office buildings. [1]
Boston Properties (BXP) - market cap $10.8B
Liberty Property Trust (LRY) - market cap $2.7B
Kilroy Realty (KRC) - market $1.5B
Corporate Office Properties Trust (OFC) - market cap $1.5B
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Commercial Real Estate http://www.wikinvest.com/concept/Commercial_Real_Estate
Hotel/Motel REITs [edit ]
These REITs focus on the development and/or ownership of hotel properties.
Host Hotels & Resorts (HST) - market cap $8.7B
Diamondrock Hospitality Company (DRH) - market cap $1.2B
LaSalle Hotel Properties (LHO) - market cap $1.2B
Strategic Hotels & Resorts (BEE) - market cap $1.0B
Industrial REITs [edit ]
These REITs focus on the development and/or ownership of industrial complexes.
Public Storage (PSA) - market cap $14.3B
ProLogis (PLD) - market cap $13.9B
AMB Property (AMB) - market cap $4.9B
Alexandria Real Estate Equities (ARE) - market cap $2.9B
Retail REITs [edit ]
These REITs focus on the development and/or ownership of properties that serve the retail sector.
Simon Property Group (SPG) - market cap $19.3B
Vornado Realty Trust (VNO) - market cap $12.7B
Kimco Realty (KIM) - market cap $8.8B
General Growth Properties (GGP) - market cap $8.2B
Other Companies that Develop Commercial Properties [edit ]
These companies develop commercial properties and sell them to investors. They depend on the health of the market to
maintain properties above development costs, so that their business is profitable. Most commercial real estate development
is financed by large Real Estate Investment Trusts (REITs, see below How To Invest in Commercial Real Estate), so firms in
this category are smaller in scale.
St. Joe Company has four segments: Residential Real Estate, Commercial Real Estate, Rural Land Sales, and Forestry,
and it builds properties for retail, multi-family, office, and industrial uses.
AMREP (AXR) sells developed and undeveloped lots to national, regional, and local homebuilders, and commercial and
industrial property developers in Rio Rancho, New Mexico.
How To Invest in Commercial Real Estate [edit ]
There are two basic ways to invest in commercial real estate: [2]
Direct Investment in Properties [edit ]
Direct investment in properties, either individually or through small partnerships, limited liability companys (LLC) , Limited
Partnerships or tenancy in common (TIC) arrangements.
Direct investment in Commercial Property offers a number of unique advantages to the investor.
Annual write offs against income through depreciation.
Sheltering of Capital Gains at the sale through the 1031 exchange.
Pass through of much higher amounts of cash flow than REIT's pass through to their investors.
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Commercial Real Estate http://www.wikinvest.com/concept/Commercial_Real_Estate
Indirect Investment through Real Estate Investment Trusts [edit ]
Indirect investment in real estate means purchasing shares of publicly listed and traded REITs - pooled properties and/or
mortgages bundled together and offered as a security. Indirect investment, through REITs, also offers advantages:
Lower risk - shares in a REIT are traded on exchanges like common stocks and are more liquid than direct property
investments.
Dividends are greater than with common stocks: between 1995 and 2000, the average dividend yield on REITs (7.3%) is
six times that of the Russell 2000 average dividend. Plus, all REITs pay dividends (they are required by law to return 90%
of gains to their investors), whereas only about half of common stocks pay dividends. [3]
There is no minimum investment in a REIT, and a portion of the dividends paid by REITs can be a nontaxable " return of
capital," which reduces the unit holder's taxable income in the year the dividend is received and defers taxes on that
portion until the asset is sold. [4]
REIT investment has a low correlation in value to that of other financial assets - like common stocks. When stock values
are in decline, institutional investors have less spending power, and this depresses value in many parts of the economy -
but commercial property often avoid this cycle since its value is tied up in long-term contracts. Because of this, REITs
possess low relative historical volatility and provide some degree of inflation protection. [5]
How the Subprime Lending Crisis has Affected Commercial Real Estate [edit ]
The U.S. Housing Market has been hit hard by issues in the financial market created by the subprime lending crisis . In
summary: inflated confidence in housing prices led lenders to give mortgages to unqualified buyers, which led to spectacular
short-term gains, and they packaged these "subprime" loans into groups (called collateralized debt obligations that were
traded like securities and purchased by some of the largest investment houses like Citigroup (C) and Merrill Lynch (MER). But
when booming housing prices started coming down, borrowers started defaulting on the loans that they never should have
qualified for in the first place, and the banks had to write down the value of their mortgage-backed assets. This created huge
losses for banks in 4th quarter 2007, and also restricted their ability to borrow and lend capital, creating a credit crunch that
has spread into other parts of the economy, restricting consumer spending and creating chaos in the markets for certain
types of securities.
But even as the residential housing market bottomed out, commercial real estate seemed to stay above the fray, and prices
stayed high. Why didn't the subprime crisis, which had such sweeping effects on seeming unrelated parts of the economy,
bring down its first cousin commercial property?
Why Commercial Real Estate Will Escape the Subprime Fallout [edit ]
Commercial properties produce income. The rents and leases of commercial buildings produce a steady stream of
revenue for their owners, which only disappears when contracts end or clients go out of business (and a recession, while
feared, has not taken effect and caused widespread business failures). In contrast, homes that are now valued at less
than their purchase price not only fail to produce revenue, but become negatively valued assets that will cost the owners
more than they paid for them. In these situations, many owners default on their loans rather than holding their under-water
homes. are under water because their value has fallen below the amount owed on them, most commercial buildings are
generating enough cash to pay off their loans. This is less likely to happen with a commercial property that can produce
revenue while the owner waits for the property value to rebound. Furthermore, commercial real estate owners are a
wealthier class than subprime mortgage owners, and they are better equipped to weather short-term losses while staying
patient in anticipation of the market's eventual rebound.
Builders have Shown Restraint, Avoiding Inflated Supply of Office Space. In the last ten years commercial developers
have been conservative in their growth strategies, generally showing restraint in order to preserve property values. Office
developers in the top 50 markets are expected to complete 53.9 million square feet of office space in 2008, according to
the real-estate data company Reis Inc. While this pace is double the expansion of 2004, it is a slower rate than in
historical periods of inflated supply. For example, in the five years prior to the commercial real estate collapse of the early
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1990s, an average 144 million square feet of new office space was delivered annually. [6]
Commercial Property Values Are Less Inflated, and will fall less, than Residential Home Values. Commercial
property values are expected to fall in the general economic contraction caused by subprime failure. But Credit Suisse
projects that home prices (which have declined substantially from their peak in 2005) will fall an additional 25% to 40% in
some places before they finally hit bottom. The average price of a house in the Miami area, which has already fallen
around 6%, is expected to tumble an additional 40%. [7] The U.S. Housing Market has collapsed due to failure at each
level of its system - from the buyer to the mortgage broker to the real estate agency to the institutional investor - but these
failings have been regulated in the commercial sector. Investors in business properties should not expect the same
unraveling effect that has decimated the value of residential assets.
Why Commercial Real Estate Won't Avoid Subprime Damages [edit ]
Developers are Staying Away from New Projects. A depressed economic state with declining stock prices and lower
spending has led institutional lenders to squeeze credit, and some property owners have been under siege - notably Harry
Macklowe who has put New York's Fifth Avenue GM Building on the block in order to appease his creditors. This forces
them to sell assets, and a flood of properties for sale means lower property values. That's not good news for REIT
investors who will see lower dividends and share prices, nor for direct investors who will have to take a loss or hold onto
properties until the market rebounds. Meanwhile, the long-term growth of the market is slowing, as commercial real estate
developers suspend growth in response to depressed economic conditions. Rather than developing new properties, firms
are opting to sign long-term contracts to keep space occupied, and extending the terms of their existing debt when it
comes due rather than aggressively negotiating new rates. This conservative approach means that investors should
expect steady rather than explosive growth once the market rebounds from its expected short-term contraction.
Institutions will take Massive Losses on Existing Properties. J.P. Morgan projects losses in the commercial property
industry will hit $120 billion in the next five to eight years - this is about 4% of the sector's $3.2 trillion in debt outstanding.
This is a major loss, but well short of the $200 billion in losses that J.P. Morgan projects in residential real estate, 15% of
outstanding debt. So while residential real estate will suffer more, the commercial sector will not be immune as property
values fall, buyers remain scarce, and supply out-paces demand. Institutions will suffer from write downs of their assets -
Goldman Sachs predicts that Bear Stearns, Citigroup, JP Morgan, Lehman Brothers, Merrill Lynch, and Morgan Stanley
will combine for commercial-property-related write-downs of $7.2 billion in the first quarter 2008, following $1.8 billion of
them in the fourth quarter 2007. [8]
Banks Own Lots of Good Commercial Loans - But They Can't Separate them from Bad Residential Mortgages. In
the fourth quarter of 2007, 7.5% of the loans to builders of single-family homes were 30 days or more past due, up from
2.1% a year earlier. Delinquent condo-construction loans rose to 10.1%, up from 2.6% a year earlier. In stark contrast,
delinquencies on nonresidential commercial mortgages were 1.6% in the same quarter, up slightly from 1.1%. [9] The
stress on small and medium-sized banks created by the failure of residential and condo-construction loans affects the
commercial market in two ways. First, the banks are more dependent on the revenues from commercial loans and may
even raise interest rates to create additional revenue, if possible. Second, these banks may be unable to lend money to
large commercial projects, especially since the credit cycle looks to be in contraction and institutions are hesitant to
finance loans and new projects. So the commercial real estate market will be guilty by association - although it continues
to uphold its debt obligations at a respectable rate, the failures of its residential relative bring down its borrowing ability
anyway.
Recent Activity in the Office Market [edit ]
Over the past several years, developers completed new buildings at an aggressive pace. 75 million square feet of office
space scheduled for completion in 2008, an increase from 53 million square feet built in 2007. However, as economic growth
slowed throughout late 2007 and into early 2008, demand for office space remained insufficient in most markets to absorb
this new development. For example, the national office vacancy rate increased from 12.5% to 12.6%. Nevertheless, rents and
occupancy rates continued to increase over the same time period in the highly competitive markets of New York City, Boston,
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Houston, and Denver. [10]
So although office landlords haven't dropped rent prices, they will have to find ways to retain customers and attract new ones
in an increasingly competitive market. Many firms have started offering more concessions to clients, such as interior
construction work and months of free rent. [11] Effective rents, which take into account concessions such as a free month's
rent upon signing a lease, were flat or falling in 16 markets in the fourth quarter of 2007, compared with seven markets in the
third quarter. [12]
Rent revenues and cash flow from commercial properties is therefore steady, but commercial assets are falling in value. This
is primarily because institutions have raised standards and slowed their lending pace, and it is becoming more and more
costly to finance the acquisition of commercial properties. Many owners borrowed aggressively from 2005 to 2007, before the
residential housing slump, and these borrowers will need to refinance their loans soon. Some won't be able to borrow as
much or get the same terms, which puts them at risk of default. Others, however, have seven- or even ten-year terms on their
loans, and this time-frame offers ample opportunity for the financial industry to resolve its issues and for the market to
rebound.[13]
References [edit ]
1. ↑ Market Cap Data from yahoo! Finance
2. ↑ SeekingAlpha, "Investing in Commercial Real Estate," 6/18/07
3. ↑ Reitnet.com, "REITs 101"
4. ↑ Investopedia.com, "The Basics of REIT Taxation"
5. ↑ "REITs 101"
6. ↑ The Wall Street Journal, "Malls, Offices May Slump Less Steeply Than Homes," Peter Grant 3/10/08
7. ↑ Statistics by Credit Suisse
8. ↑ Wall Street Journal, 3/10/08
9. ↑ Foresight Analytics, Oakland CA
10. ↑ Realestatejournal.com, 1/8/2008
11. ↑ The Wall Street Journal, 3/10/08
12. ↑ Statistics by Reis, Inc.
13. ↑ Wall Street Journal, 3/10/08
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