Commercial real estate facing trying times; no bounceback as in residential

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VANCOUVER - Canada's housing market may appear to be on the fast track to recovery but commercial real estate, which includes office buildings, industrial and retail space, still faces "very trying times," two reports released Monday show.
Commercial real estate transactions fell by more than 50 per cent in the first half of 2009 compared to last year, according to CB Richard Ellis Ltd.
It said transaction value was about $4.9 billion from January to June compared to $10 billion for the same time last year. The number of transactions also dropped dramatically to 1,569 from 2,542 last year.
"The global recessionary impact on the commercial real estate market has yet to run its course," said John O'Bryan, vice-chairman of CB Richard Ellis, which provides financing and management services for commercial real estate.
O'Bryan said the commercial market follows the general economy, and is not seeing the same kind of bounce as in the residential real estate sector.
"There is a big contrast between the two markets; one is looking as though everything is back on track and the other one looks as though it's recovering slowly."
On Friday, the Canadian Real Estate Association said residential resale activity jumped 18.2 per cent in July compared to last year, setting a record for the month. Buyers are being enticed by record low interest rates and federal tax breaks for new buyers.
BMO Capital Markets called July's sales figures a "Lazarus-like rise" from the "depths of despair" where Canada's residential real estate sector was just six months ago.
But the commercial real estate sector isn't expecting similar miracles.
"It's a very uneven recovery," O'Bryan said.
He doesn't expect the commercial market to hit close to the nearly $32-billion high reached in 2007, which he called an "aberration."
"We are now tracking this year to do around $10 billion," he said.
"The pain in the general economy isn't anywhere near through the system. The (commercial) real estate market is reflecting that."
O'Byrne said 2010 will be a year of recovery for commercial real estate, as the unemployment rate remains high and businesses still look for ways to keep costs low.
The vacancy rate for commercial office space across Canada rose to 8.3 per cent in the second quarter compared to 6.4 per cent for the same time last year, according to CB Richard Ellis data.
Scotiabank economist Adrienne Warren said commercial real estate tends to lag other parts of the economy because the projects are often large and take years and lots of money to develop.
"You need to secure fairly large tenants and secure financing. It's more complicated," she said.
She said a lot of new stock that started being built in better economic times is now coming to market, which is helping push up vacancy rates in cities such as Toronto and Calgary.
Warren also expects vacancies rates to rise further in the coming months, before eventually recovering.
However, Warren said the overbuilding is nowhere near the level it was in the late 1980s and early 90s, when commercial vacancy rates were around 15 per cent.
"We are more cautious today about building and lending," she said.
Warren added Canada's commercial sector is nowhere near as depressed as that of the U.S., where vacancy rate has surpassed 15 per cent.
The crisis in the residential and commercial real estate sectors south of the border has also led to the collapse of lenders.
Last week, U.S. regulators shut down Montgomery, Ala.-based Colonial BancGroup Inc., a big lender in real estate development and smaller Pittsburgh-based Dwelling House Savings and Loan.
Both closures boosted to 76 the number of federally insured banks in the U.S. that have failed so far this year, according to reports.
Warren said similar-style closures are not expected in Canada, where banking criteria is much more conservative.
In its report released Monday, PricewaterhouseCoopers said Canada still has "significant obstacles" to overcome before its commercial real estate sector recovers.
In fact, the consultancy said conditions are becoming more challenging as a result of tight lending conditions, less investor appetite for commercial mortgage backed securities and expectations for higher capitalization rates, which imply decreased valuations.
It also said financial weakness and sluggish growth amongst tenants is also a problem in the sector.
"The credit crisis and ensuing recession have dragged commercial real estate markets into very trying times, marked by value losses, rising foreclosures, and reduced property revenues," said Frank Magliocco of the PricewaterhouseCoopers real estate division.
"There is simply scarce money and therefore limited buyers."
Its report said "vulnerable" property types include buildings used for hotels and leisure as well as suburban office and industrial space.
It recommends property owners reassess their short and long-term needs in case vacancy rates increase further.
"In some cases, a formal restructuring process, equity injection or other non-traditional strategy may be beneficial," Magliocco said.

Organizations: Richard Ellis, Canadian Real Estate Association, BMO Capital Markets Scotiabank PricewaterhouseCoopers Colonial BancGroup Inc. Dwelling House Savings

Geographic location: Canada, VANCOUVER, U.S. Toronto Calgary

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