Commercial Real Estate, Come On Down

Here’s the next shoe to drop as a result of the bursting of the credit bubble: commercial real estate.

It won’t be anywhere near as dramatic as the fallout in the residential real estate market. But, at the same time, it won’t simply be a temporary disruption in financing followed by a modest correction in pricing that the industry is now predicting.

In markets like Washington, New York, Boston and San Francisco, the last four years have been among the best the industry has ever seen — falling vacancy rates, rising rents, soaring values and a ton of new development. Now, that’s all about to come to a grinding halt as financing becomes more expensive and more restrictive, the economy slows and a big slug of new inventory hits the market.

“It’s over,” one local developer told me this week. “It was a great ride, and now it’s over.”

You can date the beginning of the end of the commercial real estate bubble to February of this year, when the Blackstone Group closed on its $39 billion purchase of Sam Zell’s Equity Office Properties, the largest single commercial real estate portfolio in the country.

Within weeks of the deal closing, Blackstone had managed to sell off a good chunk of the Equity Office portfolio for $18.5 billion at prices even richer than it had paid.

In early June, Tishman Speyer and Lehman Holdings offered to buy another big real estate investment trust, Archstone-Smith, for $22 billion.

In the last few weeks, however, as lenders and investors have begun to come to their senses, the market for “commercial mortgage backed securities” has virtually shut down. Those are the packages of commercial real estate loans that are sold off in pieces to hedge funds, pension funds and other institutional investors. And without that cheap and easy financing, neither Macklowe nor Tishman/Lehman have been able to secure permanent financing for their deals, putting them in what you might call an awkward financial position.

They are not alone. Across the Washington region and the country, there are reports of sales falling through or held up by buyers seeking a lower price. And with financing costs uncertain, negotiations over new deals have been put on hold.

Meanwhile, developers who have just completed buildings and need to convert their construction loans into permanent financing are finding that the only lenders interested in talking are banks and insurance companies that traditionally hold their loans on their own books rather than selling them into the securities markets. These “portfolio lenders” still have plenty of money to put out, but unlike the “hot money” lenders who sell their loans, they charge higher rates and demand lower levels of debt.

All this is likely to sort itself out within a month or two. But when it does, it will have a significant impact on prices.

In recent years, commercial real estate prices have been driven up by buyers such as Blackstone and Tishman who were able to bid up prices as long as CMBS lenders were offering low-rate, interest-only financing for as much as 95 percent of the purchase price.

But in the future, if the only financing available is for interest and principal loans at 75 percent of the market value, with an interest rate a percentage point higher than before, the price that investors would be willing to pay for a building, given the same market conditions, could be 20 to 25 percent less.

Unfortunately, market conditions are not the same as six months ago.

As the Federal Reserve acknowledged last week, the turmoil in financial markets is likely to cause a slowdown in economic growth and raise the risk of recession.

And in markets like Washington, the pace at which buildings have been leasing has slowed even as a large number of new buildings are about to come on line.

According to the latest data from CoStar Group, for example, office vacancy rates along the I-270 corridor have risen to 11.6 percent from a low of 9.7 percent a year ago. Buildings under construction will add another 5 percent to supply over the next two years, with roughly a third of it pre-leased.

The market in the Dulles corridor is also beginning to weaken. There, the vacancy rate is up to 14.2 percent from 13 percent in the past year, with nearly 4 million square feet of space under construction, equal to about 8 percent of current supply. After four years of steady growth, rents are beginning to flatten out.

For the moment, the District’s office market remains strong, even as developers struggle under a glut of unsold condos. But it’s hard to imagine that the market will be able to absorb all the exciting development that is now slated to rise out of the ground over the next five years, from Union Station to the old convention center site and areas along the Potomac and Anacostia waterfronts.

Over the past year, local real estate types have tended to dismiss suggestions that the market was overheating. Their story was that the Washington economy is relatively immune to downturns, and a global savings glut would keep interest rates low. Moreover, with a large number of low-rent leases set to expire in the next couple of years, they were counting on big spikes in rental income.

However convincing that story was six months ago, it sounds a lot less convincing today.

For the real money shot, hire a pro

VANCOUVER — Photographer Russ Heinl is known for his aerial work on five films and 11 glossy picture books, including the popular Over Canada: An Aerial Adventure. But these days, he says, he’s busy in the helicopter taking bird’s-eye photos of sumptuous real estate.

In the past three months, the Vancouver Island-based photographer has shot about a dozen houses priced from $7-million to $28-million, all in British Columbia.

“Business is going crazy,” Mr. Heinl says of his real-estate photography work. The market is becoming very sophisticated, he adds, and his clients expect a high level of professionalism. “It’s got to be as slick as a Lexus commercial.”

The days of lacklustre photos snapped by realtors may be numbered. Despite digital cameras, a growing number of real-estate agents are hiring professional photographers to showcase properties online, according to Ann Bosley, a Toronto real-estate broker and president of the Canadian Real Estate Association.

Blurry photos of dark rooms, open-lidded toilets and fridge doors littered with kids’ drawings and ladybug magnets just don’t cut it.

“More and more, our clients are picture- rather than word-oriented,” Ms. Bosley says, adding that real-estate websites now accommodate many digital images.

Professional shots make sense even for low-end properties, according to Richard Silver, a real-estate agent who sells homes at all price levels in the Toronto area.

Since Mr. Silver began using professional photography two years ago, his sales have gone up by about 25 per cent, he says. “I don’t even put out a listing without the professional photos.”

Lauretta Stewart, another Toronto real-estate agent, says she switched to professional photography two years ago after using a small condo unit as a marketing experiment.

Drawn by the professional photos online, “the buyer made a special trip from Guelph to see it,” Ms. Stewart says.

One of her clients, Peter Ballon, whose house she sold earlier this month, says the professional photos helped his family prepare their home for showings.

“We noticed by looking at the photos what looked good and what didn’t,” he says, “and where there was a little more clutter.”

Annette McMillan, a Calgary real-estate agent, says expert photos are as important as staging the home.

“Even if the property doesn’t have good curb appeal, the pictures of the interior will get buyers in the door.”

Many agents don’t know their way around a camera, she says, and some don’t bother to post photos online. “But it’s like a dating service,” Ms. McMillan says. “If there’s no photo, it’s not going to work.”

Professional photography can be affordable, according to Mr. Silver. He buys photo packages in bulk from Obeo, a real-estate marketing service, at a cost of $100 for 15 to 20 shots plus a virtual tour and online mapping of the neighbourhood.

Ms. Stewart pays a similar price for services from Advirtours. “It’s a no-brainer,” she says.

But others aren’t impressed with cut-rate photo services. “I think you get what you pay for,” says Sylvia Therrien, a real-estate agent who sells multi-million-dollar properties on Vancouver Island.

“There’s a big difference between the $100 packages and professional photography,” she says.

Alan Gough, a photographer based in West Vancouver, says he charges between $300 and $400 for a two- to three-hour real-estate shoot. Mr. Heinl gets about $1,000 a day plus helicopter charter fees for his aerial work, he says.

Most real-estate agents absorb the fees as part of their marketing costs.

The technical skills of professional photography are light years away from the point-and-shoot approach, says Mr. Gough. “You have to be a Photoshop guru.”

For room interiors, for example, he takes two exposures from the same location - one to capture the interior details and another that shows the view through a window. Then he cuts and pastes the images for optimal lighting.

Another technique, he says, is to use a wide-angle lens to make rooms look roomier.

Ms. Therrien of Vancouver Island recently hired photographer Erin Brûlé to shoot a $17.5-million estate in the prestigious Uplands district of Victoria.

Ms. Brûlé says she visited the property four times to get the right shots of the interior and exterior.

In her photos of the property at Luxurywaterfront.ca, chrome bathroom fixtures glint in the sun and chairs in the garden are arranged as if the owner is about to sit and admire the view.

The idea is to make prospective buyers envision it as their own home, Ms. Brûlé says, “and not just a piece of property.”

At the opposite end of the spectrum, ill-conceived photos still proliferate on many real-estate websites. But instead of being the norm, they are now objects of derision by bloggers such as Saskatchewan real-estate agent Norm Fisher, who posts his Unbelievably Bad Real Estate Photo Hall of Fame at Teamfisher.com.

Real-estate agents have no excuse for using poor-quality photos of the properties they are paid to market, says Ms. Stewart. “I’m surprised that the sellers let them get away with it.”

Tricks of the trade

Can’t afford a professional photographer? Borrow these tricks of the trade from Photographyforrealestate.net:

Remember that the photo’s purpose is to sell real estate. Focus more on the architecture and room spaces than on furniture and decor.

Simplify images. Exclude everything that detracts from the home’s attractiveness, such as towels hanging from the oven door.

Viewthe front exterior as the key shot. Spend extra time on it, since this is the image often required by Multiple Listing Service rules.

Render interiors light and bright. Since light interiors are more attractive to buyers than dark ones, use an external flash unit or a long exposure shot on a tripod to make a room look bright.

Keep the verticals vertical. All vertical lines, such as wall corners, should be shown parallel to the sides of the image, otherwise they distract the viewer’s attention. If the use of a wide-angle lens creates distortion, restore verticals with digital photo-editing.

Stick to horizontal shots. Most real-estate websites are designed to work best with landscape-mode images; a mixture of horizontal and vertical formats can be distracting.