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Riding the Recession-Rick Chichester

Office? Industrial? Multifamily? Retail? Which commercial real estate sectors are best positioned to weather the current economic storm?

HOUSING SLUMP, INFLATION fears, record oil prices and the fall of a major Wall Street bank-are there any safe havens left? At the time of (his writing, the U.S. economy has not yet been officially categorized as being in a recession. However, there is a growing consensus by many of the country's foremost economists that we are in a recession and, more to the point, that we are in a structural recession as opposed to a cyclical recession.

Unlike the more recent recessions-two led by the actions of the Federal Reserve and one, most recently, led by the hyper investments of the technology bubble-this current recession has been caused by the credit markets and the consumer. This is significant because the last time the credit markets and consumer led the economy into a recession was 1929.

However, unlike that former period, we now have the oversight of the Federal Reserve and their actions have stabilized the markets to some degree by infusing liquidity into the financial systems. So, what does this mean for the value and pricing of commercial real estate?

The commercial real estate market of the recent past has been principally motivated and underwritten from a financially engineered view of "value"-the low cost of capital (debt) and the expectations of continued appreciation. This financial strategy of value through low-cost, high-leveraged debt and appreciation is not sustainable, and the optics through which we view the asset of commercial real estate needs to be re-focused back to the fundamentals of income cash flow-operational expertise and value enhancement.

In general, the commercial real estate market is stable - it's not overbuilt, as in the late 1980s -and corporate America is profitable and business is sound. Going forward, the success of the commercial real estate market will center around operational value - tenant recruitment and retention, energy and mechanical management, and property management.

Experts within the real estate industry predict that commercial values will decline, causing capitalization rates to increase 75 to 200 basis points, as the commercial real estate market returns to its fundamentals. However, the still-to-be-determined issue surrounding real estate is the financial structure of many of the portfolios. With the limited transparency of the mortgage and debt markets, it's hard to know just what are the true financial conditions of many of the properties or their ownership.

It's safe to assume that much of the financial market is interwoven and that many of the commercial properties are cross-collateralized. Consequently, if, as predicted, values decline (capitalization rates rise), there will be owners who will be compelled to sell some of their assets to satisfy their lending requirements of debt-to-equity ratios. Additionally, there is a flight to quality, suggesting that it will be the trophy assets that will sell. As we look forward, the asset class of industrial looks to be the strongest, as the global demand for consumer goods continues to expand.

Logistics is expanding throughout the world. Multifamily is good in most major markets, as housing depreciation and new and stricter lending requirements are keeping many would-be home buyers in the rental market. Office is stable as corporate America is sound, and business is profitable (the wild card is any significant change in unemployment).

Retail is the asset class with the most apparent risk due to its dependence on consumer spending. There is incredible financial capital pacing the sidelines, eager to get into the market. The issue in the near-term is that nobody knows how to price risk. When the financial markets can create a clear and rational strategy, the capital markets will return stronger than before, and commercial real estate will certainly be one of the investments of choice.

Rick Chichester is President - Us. Operations for CMN, the largest member firm 0/ Colliers International. Rick is responsible for overseeing the operations 0/all business units for CMN in the USA, as well as all related partner companies; inclusive o/brokerage, real estate management services (REMS) and appraisal and valuation, and mortgage. Rick has vast executive-level commercial real estate experience with specific skills in the areas of strategic planning, market segmentation, operational and financial management.