Market Data

Commercial Real Estate Markets Tackle Unique Challenges

The United States is facing many challenges as we enter 2002. The Federal Reserve Board cut interest rates dramatically throughout 2001, and a previously wobbly economy has plunged into a recession. On the political front, fear and uncertainty present unique challenges with far-reaching consequences. The current administration is faced with assessing strategies that not only will impact the United States but the world as well.

To some extent, the current situation mimics what the nation faced in 1990 and early 1991 during the Persian Gulf War. However, a decade later, we are looking at a far subtler, long-range structural impact on the United States and its overall economy. As this is an unconventional situation, its consequences will be commensurately unique.

As during the early 1990s, the commercial real estate industry is feeling negative impacts due to these external factors. Each property type is responding in a different manner, and some are faring better than others. Financial entities such as commercial mortgage-backed securities are feeling the effects as well, which will impact the ability of property owners and developers to refinance struggling properties or fund new ones.

The Markets React As we begin the new year, the aftermath of the September 2001 tragedy continues to reverberate through the commercial real estate markets. The effects on the economy and, more importantly, consumer confidence strongly influence the performance of most property types. Some inferences can be drawn from the consequences of the Gulf War; however, many ramifications of the current situation have no previous comparison.

Hospitality. The lodging and leisure industries are experiencing the greatest impact of the current economic downturn. Travel remains suppressed, similar to the Gulf War era. In 1991, the travel industry suffered significant losses due to fears of flying, diminished confidence in the economy, and increased inconvenience from security measures. Parallels exist in today's current situation.

Restricted travel affects not only the leisure sector, but also business activities. According to Bear, Stearns & Co. and Smith Travel Research, the Gulf War produced changes in both demand for rooms and room rates. Quarterly occupancy dropped about 4 percent overall in the first quarter of 1991 vs. the first quarter of 1990, and room rates fell approximately 5 percent to 8 percent for the same period.

Markets reliant on business and tourist travel such as New York, Boston, Los Angeles, and Hawaii experienced far more pronounced changes. The top 15 hospitality markets saw occupancies decline by more than 5 percent and room rates decline by approximately 8 percent for the same period.

That said, the same research indicates that for a year-to-year comparison, the impact of the Gulf War was far less significant. For 1990 vs. 1991, hospitality demand was approximately the same, and rates declined only 2 percent to 3 percent. While this varied between luxury, full-service, and limited-service hotels, it indicates that the immediate reaction to these market dislocations is far more dramatic than that of a longer period. In fact, six to 12 months after resolution of the Gulf War, many markets remained relatively strong despite the subsequent 1991 recession.

During 2001, the faltering economy, a falloff in corporate earnings, higher unemployment, and declines in most equity markets pushed the hospitality segment into recession. As such, construction slowed and continues to slow; therefore, significant new supply should not aggravate this sector's metrics any further.

The current situation presents the lodging, gaming, and cruise industries with the greatest challenges they have seen in 10 years. Economic uncertainty will cause business and leisure travelers to reconsider travel and lodging plans, resulting in potentially severe consequences.

Office. In the office market, companies are revisiting their strategic real estate needs. Decisions such as lease renewal vs. relocation and central vs. decentralized operations are under review. In addition, companies are re-evaluating the traditional competition between suburban and central business district markets. Due to recent events, more modest, low-profile space is gaining acceptance with top-tier tenants.

Concurrently, building owners are coping with rising expenses for security as well as soaring insurance costs. The cost and availability of insurance product also is affecting new transactions, but the long-term effects are uncertain at this time.

Multifamily. Troubles in the multifamily market have been exacerbated by the overall decline of the economy and concomitant loss of jobs. These recessionary signals will lead to higher apartment vacancies as tenants attempt to save money by doubling up, moving, or seeking other living arrangements. Landlords also will experience the inability to raise rents and the added cost of extra security measures that tenants will demand, especially those in high-rise structures. Developers of condominium projects will see decreased sales activity as people put off buying homes until better economic times.

CMBS. The CMBS market is challenged just as much as the property markets. Commercial Mortgage Alert reports that through early September 2001, U.S. CMBS issuances were $47.5 billion, compared to only $27.3 billion for the same period in 2000, and the CMBS market was poised to set a record for both domestic and international issuances. However, the market slowed to a crawl after September. Many conduit lenders put new business aside in the fourth quarter as they worked on pipeline deals, and much of September's schedule did not come to market. Insurance companies, on the sidelines, assessed how to write insurance, delaying transactions.

As a result, some property types, such as hotels, are not marketable in the CMBS arena. However, the U.S. CMBS market is deep and resilient. While not record breaking, 2002 is poised to be an outstanding year. Five- and 10-year issuances will be in need of refinancing, and issuances previously set aside will be revisited. The depth of the nation's capital markets will continue to provide economic stability to commercial real estate finance.

While the current slowdowns in the hospitality, office, and multifamily sectors are discouraging, it is challenging to predict how commercial real estate markets may respond to economic and political activities in the year to come.

Jack Barthell

Jack Barthell is partner in charge of real estate capital markets at PricewaterhouseCoopers in New York. Contact him at (212) 596-7280 or


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