Commercial Real Estate – The NEW Normal

0911commbuildings

Investors, developers, bankers and contractors adjust to a depressed real estate climate

Story by Sean Fitzgerald, New North B2B publisher

When recessions hit, the economic calamities take many forms, from a slowdown in customer orders and cutting back business operations to layoffs and even closure.

Perhaps no where else is the impact of such a downturn as tangibly visible as the commercial and retail real estate market, where business closures and downsizing take the form of empty storefronts and vacant office spaces.

To say the least, areas of northeast Wisconsin have their share of “For Sale” and “For Lease” signs up at buildings across the region. That’s had an impact on landlords and developers across the New North, who often concede to more lenient lease terms to keep existing tenants and to lure new tenants to fill vacant space. It’s also contributed to lower sale prices on properties owners hope to unload – perhaps a potential treasure for a would-be owner who can step up to the deal with enough financing – but a bit of a raw deal for the seller, as well as for owners of similar nearby properties, of which values can drop considerably.

“Nothing (in real estate) is worth the value that it was three years ago,” noted Steve Seidl, a more than 40-year veteran commercial office real estate broker and founder of Seidl & Associates in Green Bay. Similar to the housing market, a number of relatively new multi-tenant office and retail projects built on spec by developers that couldn’t cash flow enough to pay the bank have been foreclosed upon. The bank, in turn, needs liquidity and doesn’t want to hold on to the property long, so it’s sold at sometimes half the value that it might otherwise if sold through a private-party transaction.

“That’s created a lot of deflation in the marketplace,” indicated Seidl, noting that property value deflation has risen to double-digit percentages for the first time in nearly a century. He believes these years will be regarded as a historic period of our economy.

“It’s a downward spiral, and it’s difficult to see how it ends,” Seidl said.

Not all real estate professionals in the region view the local commercial real estate environment quite as grim. Appleton-based Pfefferle Companies President Mike Pfefferle feels the commercial real estate market in northeast Wisconsin was spared much of the devastating toll it took on other markets around the country, and said there’s already signs a rebound is on the horizon.

“The recession that hit the country didn’t hit us as hard here in Wisconsin, and so we didn’t quite see the dip in (commercial) real estate that most of the country saw,” said Pfefferle, whose company manages commercial properties through its Pfefferle Management division and also brokers commercial, retail and industrial properties through its Grubb & Ellis/Pfefferle brokerage.

The brokerage releases a semi-annual office trends report for the Fox Cities market and separate report for the Green Bay area. It’s most recent report for Green Bay indicated office vacancy rates have been leveling off at about 15 to 16 percent since late 2009 and still remain lower than the 18- to 19-percent range where vacancy rates hovered in Green Bay during 2007 and 2008 prior to the start of the recession. In the Fox Cities, office vacancy rates have continued to trend upward to nearly 17 percent as of the first quarter of this year, but rental prices have remained relatively stable since late 2007, dropping less than $1 per square foot for prime Class A office space.

“There’s some moving around of tenants,” said Pfefferle, noting that some are moving from more expensive Class A space to a little less comfortable – yet, manageable – Class B office space. For the most part, however, tenants have been in the driver seat for a few years now.

Leasing space

If your business leases its office or retail space from a landlord and you’re approaching the end of the current lease agreement, chances are you’re still in a good position to negotiate even more favorable terms than you might already have in writing.

Though not universally the case, landlords suffering from less-than-forecast cash flow due to unexpected vacancies may be willing to make some concessions to steady, long-term tenants to keep them on site.

“I think landlords have realized it’s better to keep the tenants in there than to have to look for another tenant and let the space sit empty for a while,” said Steve Kremer, a commercial broker with Adashun Jones Real Estate in Fond du Lac. Kremer said he’s spent more time than ever before working through negotiations on re-doing leases with existing tenants of his clients, simply because tenants have so many other options making it cost-effective to pick up and move.

Seidl points to a similar dynamic in the Green Bay market.

“The cost of vacancy is very high (to a landlord),” Seidl said. “And the tenants know that.”

Lease concessions have meant everything from lower pricing to rent space to shorter lease periods, even some situations where existing tenants are entitled to lease space on a month-to-month basis. In retail environments, concessions have meant newer, more creative provisions at the lease signing.

Grant Schwab, a commercial real estate and development representative with First Weber Group Commercial in Oshkosh, said he recently negotiated with a national retailer to move into a vacant Oshkosh retail store with the provision that the retailer could break the lease without penalty if their sales numbers at that particular location didn’t meet a certain threshold. Schwab said that kind of negotiation by retail tenants has become more common as national retailers look to spur the growth of their store count with as little long-term risk as possible.

Buying a building

Of course, with the increased amount of vacant office and retail property available compared with four years ago, an interested buyer can get a real deal if they can come up with the financing to cover the negotiated price. That’s been the case across the country.

“I have properties listed with clients where they’ve had to come down on their prices substantially from three years ago,” said Tom Scharpf, a commercial and industrial broker and owner of Oshkosh-based Thomas James Real Estate.

With low interest rates and low selling prices, now is the time to do a deal for any investor who has the cash, said Adashun Jones’ Kremer, who noted, “I’m starting to see ‘Sold’ signs again.”

That has been the case for a number of investors who’ve withdrawn from the volatility of the stock market and parked substantial portions of their portfolio in investment real estate.

“We’re having a tremendous year selling to investors,” said Schwab of First Weber, indicating investments in apartment buildings have been popular. Schwab said these investors acknowledge that a stock value can literally drop down to just a few pennies in a relatively short period of time, and all the investor has remaining is a few pieces of paper proving they own the stock. With a building, Schwab said, it could still lose a substantial portion of its value in a worst-case situation, “but at the end of the day, you still have bricks and mortar.”

Changes in the real estate climate have made their mark in the banking community, where banks have taken a much more strict approach to non-owner-occupied developments. In such projects, banks now often require double the amount of cash they might have to write a loan for such a development four years ago. In some cases, the bank won’t loan funds for such projects altogether.

“Because there’s been such a correction in value, banks are requiring more cash in,” said Will Deppiesse, a vice president with First Business Bank Northeast. At the same time, banks are facing new, tougher rules from regulators designed to prevent many of the financial calamities that led up to the recession in late 2008.

“I think the days of doing a development with little to no cash in – I just don’t see that working anymore,” Deppiesse said.

Not too worried, though, Deppiesse said banks still receive a good deal of real estate financing activity for re-financing as well as financing requests for build-outs and alterations of vacant space. Those opportunities continue to grow as more businesses looking to expand buy existing buildings at a bargain and retrofit the facilities to suit their operating needs.

Building new versus buying used

Of course, the perceived downturn in the commercial real estate market has also had an impact on commercial contractors. For those businesses willing to step into an existing facility and make it accommodate their operations – either by simply putting up with the configuration or hiring a construction contractor to renovate and alter it to fit their needs – the sticker price to buy the property can prove to be a bargain. Much more so than buying new.

Ironically, that was case for Green Bay-based general contractor DeLeers Construction, which needed to expand into a different facility. Late last month, the builder of commercial structures moved into vacant warehouse and office space in the same building with Orde Sign & Graphics in De Pere, rather than building a new headquarters for itself, said Paul DeLeers, senior business development consultant with DeLeers Construction.

“From a cost standpoint, it didn’t make any sense,” DeLeers said. “For us, we needed basic office space and we needed basic warehouse space.”

But using an existing facility isn’t the best choice for every business. Kaukauna-based Keller Inc. has fared well during the past three years with a variety of new commercial, industrial and agricultural construction projects. In many cases, according to Keller President and CEO Wayne Stellmacher, its clients have discovered some of those real estate bargains, but ultimately decided the cumulative costs of moving into an existing building couldn’t be justified.

“When people build a new location they invest substantial dollars,” Stellmacher said. “When they have looked at so-called ‘bargains’ and find out what it costs to make it acceptable and the concessions they have to live with, most of them are building new. The old saying, ‘if it’s too good to be true…’ has played out in many of these situations.”

By and large though, a majority of the commercial building permits issued across northeast Wisconsin so far in 2011 have been for alterations and additions to existing buildings rather than for entirely new construction. But even though the price tags on such projects are a bit less than a new construction, they still help pay the bills for contractors and keep crews on the job. Both Keller and DeLeers have had their share of building addition, renovation and alteration projects during the past year or so since the number of new building projects has virtually ground to a halt.

Particularly in cases with office space, builders are discovering business owners are much more economical and willing to allow the price to dictate where they locate and the kind of space they call home. In one example, said Bob Albright , Jr., a project manager and estimator with Oshkosh-based general contractor R. J. Albright Inc., they have a client who owns two office locations and is looking to remodel one office, consolidate the staff into that location once it’s complete, then lease out the second location for additional income.

“I find with office spaces, businesses will look to go anywhere,” Albright said. “I think the remodeling end is something builders definitely have to pay attention to.”