August 11, 2009 10:00 AM ET | Rick Newman | Permanent Link | Print
The worst of the housing bust might finally be over, but another real estate tsunami is about to swamp many American cities. This time, it will be office buildings and retail space going vacant and facing foreclosure.
Like housing, commercial real estate goes through booms and busts, and the coming wipeout is likely to be a doozy. Commercial developers went on their own spending spree earlier this decade, racing to cash in on the hot economy with new office towers, hotel complexes, and retail projects. Banks supplied hundreds of billions of dollars in loans, often assuming that rents paid by tenants would keep going up. “The assumption was that the good times would go on forever,” says Victor Calanog, director of research for REIS, a real-estate-research firm.
[See 10 Cities Primed for a Real Estate Recovery.]
If that mistaken assumption sounds familiar, so will the ramifications. Instead of going up, commercial rents have begun to plunge as companies downsize, warehouses empty, merchants go out of business, and huge retailers like Starbucks and Macy’s close underperforming stores and demand rent reductions. Office and retail vacancy rates are near record levels and going higher, and developers are about to face crunch time as billions in loans come due for repayment or refinancing over the next three years. Like homeowners who are “under water” on their mortgages, many of those developers owe more than their buildings are now worth.
The commercial crunch won’t hit consumers as directly as the housing bust, but they’ll still feel it. A resurgence in construction spending is often the springboard out of a recession, but in dozens of overbuilt areas, it won’t be. Many shopping centers could close completely. Urban development projects have been put on hold or canceled, giving blight a reprieve instead of chasing it out of town. As many as 3,000 banks may face significant losses on commercial real estate loans, according to economist Gary Shilling, which could crimp other lending and even threaten the banks’ solvency as losses start to pile up.
To determine which cities are most vulnerable, U.S. News analyzed data from REIS covering retail and office vacancy rates in the 79 biggest metro areas. At our request, REIS combined its retail and office data into a single commercial vacancy rate for each city, for several time periods. The research firm also provided its 2010 projections for each city.
[See America’s most endangered and most profitable malls.]
To gauge the impact on each city over the coming year, we measured the difference between the commercial vacancy rate in 2008 and the projected rate in 2010. So the cities that landed on our list won’t necessarily have the highest vacancy rates next year, but they’ll experience the biggest increase over a two-year period. In most of these cities, commercial real estate woes are likely to hamper a recovery. In a few, they’ll compound a set of problems that’s already profound. Here’s where the next real estate bust is likely to hit hardest:
Las Vegas (projected commercial vacancy rate, 2010: 18.1 percent, up 6.8 percentage points from 2008). What happens in Vegas depends on the rest of the American economy, and until Americans start to feel wealthy again, travel (and gambling) budgets will remain crimped. Southern Nevada already suffers from one of the worst housing busts in the nation and a 12.3 percent unemployment rate. Vegas had a hot hand earlier this decade, which led to lots of commercial construction. But nearly one fifth of Sin City’s commercial space will stay vacant until tourists, conventioneers, and their cash start to return.
[See 8 industries that will sit out a recovery.]
Baltimore (15.8 percent, up 6.5 points). Several large universities and proximity to recession-resistant Washington, D.C., have propped up Baltimore’s economy, but the city is still exposed to many economic strains. With the nation’s retail sector in a tailspin, shipments in and out of the Port of Baltimore have tanked, leaving acres of vacant warehouses. Other development programs have stalled as businesses have cut back on spending. Mayor Sheila Dixon has also been indicted for suspicious dealings with area developers, casting a pall over Baltimore’s business climate.
Detroit (24.8 percent, up 6.3 points). What else could go wrong in Motor City? Two of the area’s biggest employers, General Motors and Chrysler, declared bankruptcy this year, and the whole auto industry is undergoing severe cutbacks amid the biggest sales plunge in decades. So many companies have left Detroit that there’s barely a rush hour in this once bustling metropolis. If there’s any good news, it’s that prime office space is cheap: Rents have fallen eight years in a row and are likely to drop an additional 13 percent through 2010, according to REIS.
San Bernardino/Riverside, Calif. (15.9 percent, up 6.3 points). The availability of land once made Southern California’s “inland empire” a housing hotbed, with hundreds of mortgage brokers and a booming retail sector. No more. A vicious housing bust could ultimately drive home prices down 65 percent from peak values, and the unemployment rate could hit 16 percent next year. That’s knocked many of the mortgage brokers out of business and devastated the area’s ubiquitous strip malls. Even government jobs have been disappearing, thanks to California’s budget crisis.
[See the industries hurt most by soaring healthcare costs.]
Hartford, Conn. (20.2 percent, up 6 points). A recent survey identified Hartford as one of the first cities to bounce back from the recession, but local economists are doubtful. Many of the city’s insurance firms have slashed jobs in response to the financial meltdown. Aircraft-engine maker Pratt & Whitney may close two local plants, and the Obama administration’s push to end production of the F-22 fighter jet would hurt defense contractors in the area. With little new construction over the past year, most of the increase in vacancies is coming from businesses scaling back or shuttering their operations completely.
Dayton, Ohio (22.8 percent, up 5.9 points). After 125 years in Dayton, NCR is closing up its headquarters and moving to Georgia, taking 1,300 jobs with it and leaving more than a million square feet of office space behind. The collapse of the auto industry has also hurt the area, with several local parts suppliers dependent upon the Detroit automakers. In a survey of the 100 biggest cities, the Brookings Institution ranks Dayton near the bottom in terms of lost jobs and economic output.
New York (12 percent, up 5.9 points). Those lavish Wall Street bonuses you’ve been hearing about are going to a lot fewer bankers. The financial industry, Manhattan’s mainstay, has contracted by about 7 percent over the past year. Other industries have lost even more jobs, causing a sharp reversal in what used to be one of the world’s hottest real estate markets. Office rents skyrocketed in 2006 and 2007, when Wall Street was at its peak, but REIS expects them to fall 28 percent between 2008 and 2010. REIS’s vacancy data for New York include only office space, so the combined vacancy rate including retail space is probably higher than 12 percent.
Charleston, S.C. (16.6 percent, up 5.8 points). The antebellum charm has worn thin as this low-country mecca hopes for tourists to return and trade at its port to pick up. Several ambitious downtown hotel and redevelopment projects have stalled while developers wait for the economy to revive. Elsewhere in the state, manufacturing, retail, and construction companies have shed thousands of jobs, many of them gone for good. When not addressing his extramarital affair, Gov. Mark Sanford attempts to woo new businesses to the state.
Tacoma, Wash. (13.6 percent, up 5.8 points). Shipments are down at the city’s port, one of the nation’s biggest, which has left warehouses vacant and hammered the many area businesses that depend on trade. And many of the region’s most prominent companies, including Microsoft, Boeing, Starbucks, and Washington Mutual—taken over last year by JPMorgan Chase—have been laying off workers, helping push Tacoma’s unemployment rate higher than the state average.
New Haven, Conn. (17.2 percent, up 5.8 points). Education and healthcare have helped stabilize New Haven’s economy, but even Yale University has scaled back development plans and laid off workers, after its famed endowment dropped by $6 billion because of stock market losses. And a long-term shift away from manufacturing toward financial services and other white-collar industries has left the city exposed to the financial meltdown. That means New Haven’s recovery will probably lag the nation’s.