2010 NorCal Commercial Forecast from Grubb Ellis

Grubb Ellis released it’s 2010 Northern California/Central Valley Forecast report.

Here are some highlights:

In the past few months, with the credit markets stabilizing, commercial real estate has developed a somewhat unfair reputation as “the next shoe to drop.” No doubt there is pain ahead, as losses are realized and the industry is recapitalized at lower values, but this transition is highly unlikely to repeat the disruption caused by the housing crisis for reasons we discuss in our analysis. The re-pricing of assets is generating opportunities unseen since the early 1990s, notably for tenants and investors with cash.

The economy is improving thanks in part to quick actions by governments around the world. Recovery will be slow, however, particularly in the labor market. Because tenant demand for commercial real estate derives from job growth, the leasing market will struggle in 2010. Tenants will have the upper hand in negotiations with landlords, resulting in flexible leases and hefty incentive packages. A shortage of debt capital will continue to affect the investment market, but there is a growing pool of equity capital forming to acquire property assets at bargain prices.

While we expect real estate sales to pick up during the year, banks have delayed selling their REO properties in order to protect their capital reserves. As a result, distressed assets will likely come to market over the next two, three or even four years. CMBS will provide opportunities for investors to acquire distressed debt in 2010, but the structure of the original agreements often makes the process more arduous than buying a property or a whole loan from a bank.

Predictions for 2010…

As the recession ebbs, discussion has turned to the shape of the recovery, with letters of the alphabet being the most popular descriptors. The possibilities are framed by the optimistic scenario of a brisk rebound (a “V”) and the pessimistic scenario of a doubledip
recession or zero growth following a stimulus-fueled bounce (a “W”). In between are weak but sustainable recoveries of varying lengths – a “U” depicting a jobless period of moderate length, and an “L” where the weakness lasts longer, perhaps much longer as occurred in Japan during the 1990s.

We believe a U-shaped recovery is most likely, with the labor market bottoming in the second half of 2010 and sustained job growth returning in 2011. The labor market is unlikely to recoup the 8 to 9 million lost jobs until 2014 or 2015. Inflation will not be an issue in 2010 but could become a problem down the road unless the government takes steps to control its debt. A little inflation could burnish real estate’s long-dormant reputation as an inflation hedge.

Regarding Commercial Real Estate…

In the investment arena, we anticipate transactions to increase 20 to 30 percent in 2010 compared with last year’s artificially low levels. This is likely to be the start of a multi-year recapitalization process for commercial real estate where banks, CMBS servicers and other lenders finally write down and sell a steady river of distressed assets. Prices, already down 40 percent from their peaks, may decline another 10 percent as buyers finally get in the game. Anecdotes suggest that capitalization rates for apartment and medical office properties actually fell slightly late in 2009 as credit market panic abated, so prices may be finding a floor.