The Collapse of the U.S. Economy

Commercial Real Estate Follows the Housing Market Off the Cliff

March 17, 2010

New York Times - Perhaps it was just a matter of time, but three years after this city’s housing market collapsed in spectacular fashion, commercial real estate has followed it off the cliff.

The average price paid for office space in the Phoenix metro area tumbled more than 50 percent last year, from $205 a square foot in 2008 to $102 a square foot in 2009, according to data compiled by Kammrath & Associates, a local real estate analysis firm. Retail and industrial space underwent similar declines.

“Prices are falling like a stone,” said Bob Kammrath, who has studied the commercial market in Phoenix since 1981. “I see them going lower.”

The recession has been the main instigator of the crash, but overbuilding and speculation set the stage. In a mirror image of the housing bubble, relaxed lending standards and a boom mentality prompted the construction of hundreds of offices, shopping centers, industrial buildings, hotels and apartments from 2005 to 2009 — about 86.5 million square feet of new commercial space in all, according to research by CB Richard Ellis.

In 2006, when growth peaked, about 30 percent of the Phoenix area’s economic output was tied to real estate and construction. So it was not long after the once white-hot housing market fell apart, in 2007, that the rest of the city’s economy stumbled, and hard. As jobs in construction and real estate dried up, and stock market losses curbed the relocation of retirees from the north, in-migration to the city radically slowed.

Commercial brokers blame a confluence of factors for the worst downturn in memory: rampant overbuilding, a national economic crisis, spiking unemployment and a near halt in population growth. The result is visible all over the city in the form of empty storefronts and “for lease” signs affixed to office buildings.

The worst-off of these projects were built in marginal locations on the outskirts of the metropolitan area, and stand completely empty months and even years after completion.

“We’ve got some see-through shopping centers,” said David Wetta, senior vice president and managing director in the Phoenix office of the real estate brokerage Marcus & Millichap.

A handful of major developments throughout the metro area simply collapsed midconstruction and linger, half-built, as gloomy reminders of the sudden end of good times.

One such failure, the Hotel Monroe, sits in the heart of downtown Phoenix, just a few blocks from City Hall. Started in 2006, its plans were extravagant even by the bloated standards of the bubble era. The 144-room boutique hotel was to be housed in a rehabilitated 12-story Art Deco office building from the 1930s and would include opulent “Rock Star” suites, a five-star restaurant, a rooftop nightclub and 24-hour room service.

Construction began in 2007 but ground to a halt a year later when the project’s banker, Mortgages Ltd. — for a short time, Arizona’s largest private lender — cut off financing, en route to its own bankruptcy. The hotel remains unfinished, with dark windows and a desolate mien; Grace Communities, its developer, was recently cited by the City of Phoenix for code violations including graffiti on exterior walls and trash and debris around the premises.

When or how the hotel will be finished is uncertain, as the building is in foreclosure and headed to a trustee’s sale in April. There, 13 investors will try to recoup $76.5 million in loans, though experts say the building is unlikely to fetch anywhere near that amount.

Yet it is not just new commercial developments that are foundering. Older properties — in particular, those that sold at big premiums during the market run-up — are also struggling with rising vacancy rates, shrinking rent rolls and high debt loads.

A prime example is the Viad Corporate Center, a 24-story, 478,000-square-foot high-rise in midtown Phoenix, which was built in 1991 and bought for an estimated $105 million in 2006. Earlier this month, Bank of America filed a motion in court to appoint a receiver for the property, citing the failure of the building’s owner to stay current on a $65 million loan.

Bank of America’s move to foreclose on the tower is one prominent sign that lenders are losing patience with large commercial borrowers and are stepping up efforts to resolve problem loans behind big properties. Commercial mortgages in Phoenix are souring at their highest rate in years: according to Foresight Analytics, a banking analysis firm, 5.3 percent of commercial mortgages in the metro area were delinquent in the fourth quarter of 2009, up from 2.3 percent at the same period in 2008.