Commercial real estate falling apart

Commercial real estate in America is nowhere as bubblicious ;) as residential real estate—or Japan circa 1989. Nevertheless, it is an area that will likely face stresses and probably end up with the biggest bust since 1990. The Globe & Mail picks up Reuters story that illustrates some of the fire-sales that have occured on prestigious buildings:

The 40-storey skyscraper sits on a prime corner in the country's wealthiest commercial market, steps from the Museum of Modern Art and a few blocks from Rockefeller Center and Central Park. It recently sold for $100,000 (U.S.).

The 1330 Avenue of the Americas building - which sold for close to $500-million three years ago - was auctioned last month for the minimum to a unit of the Caisse de depot et placement du Quebec after owner Harry Macklowe defaulted on a $130-million loan.

A month before that, the John Hancock Tower - Boston's tallest skyscraper - sold at auction for just over $20-million. The 33-storey Equitable Building in downtown Atlanta is set to go up for auction next month; its owners owe more than $50-million to the bank and have only half of the building leased. Loan defaults in the worst commercial real estate market in decades have created tens of billions worth of distressed properties across the U.S., forcing cut-rate auctions of landmark skyscrapers.

From these ashes, some investors will rise and make their name. I remember how Sam Zell went around and bought highly valuable properties for very low prices (usually $1), only to sit on them, cut operating costs, and wait until they turn around. The fact that a valuable skyscraper in a highly attractive part of town can be bought for $100,000—real cost is probably $130.1 million if the full loan had to be covered—and which traded hands for $500 million three years ago shows the state of affairs.

Small investors can't buy these things directly but anyone interested may want to start digging to see if there are REITs, publicly traded private-equity funds, and the like, with strong balance sheets that are attempting to purchase these distressed properties. I have little interest in real estate so I don't follow it, and I don't know much about it. But, similar to cyclicals such as autos, if you can buy at a low price during poor economic times, you may reap huge rewards later on.

Having said that, one needs to be extremely careful—similiar to anyone betting on consumer discretionary right now. I remember reading Jim Grant's Trouble with Prosperity and how most of the buildings in Manhattan, including a prestigious one covered in detail in the book, never recovered for more than a decade. Based on the wildly-inflated projections used to justify the project during 1929, some buildings never satisfied the original estimates for 20 or 30 years. So, the lesson here is that even if prices decline, they may still be too high.


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