Commercial Property Values Expected to Decline Further

Real estate owners and investors are expecting further declines in commercial property values over the next 12 months as tenant demand weakens, rental rates decline, and overall cap rates rise, according to the quarterly findings of PricewaterhouseCoopers’ Korpacz Real Estate Investor Survey. And some of these declines could be steep. In addition, with buyers and sellers in a stalemate, loan default rates and distressed sales are expected to rise, which some investors fear will lead to a market overcorrection, erroneously driving down values and undervaluing many commercial properties.

Overall, surveyed investors anticipate a further 10 percent average loss in value across all commercial property sections and geographies. Among the largest sectors, surveyed investors expect an 8.5 percent average decline in regional malls, an 8.2 percent decline in warehouse, and an 11.4 percent average decline in national central business district office values (close to a 12.0 percent average decline in suburban office assets).

Though survey responses indicate that the office sector is expected to see the steepest decline in value over the next 12 months, there are regional differences. Investors expect the biggest office market declines in Dallas (17 percent), San Diego (16 percent), Atlanta (13.5 percent), and Houston (12.5 percent). In contrast, they expect the office markets of San Francisco, Boston, and Washington, D.C. to see below-average declines.

The majority of the commercial real estate industry is expected to remain in recession through 2011, according to the PwC survey. While a recovery is expected to start to materialize in the office and retail sectors in 2011, it will not dominate these sectors until 2012.

On top of that, buyers and sellers are in a stalemate. Buyers, who are unwilling to pay for empty space and speculation, claim that sellers have not fully adjusted their asking prices to reflect significant changes in market conditions and lending restrictions.

Surveyed investors are concerned about the drop-off in tenant demand and the growing levels of sublease space and shadow space in the office sector. Corporate America is conserving cash by returning space to the market, and the pendulum has swung in favor of the tenants. Investor anxiety is noted by the use of much lower market rent growth rate assumptions in their valuation analysis.