The Clarus Blog

It was only a matter of time before deteriorating market fundamentals began to affect every asset class, and it’s a rare property that hasn’t been hurt by falling rents or occupancy.

National apartment and retail vacancy is now at record highs (going back to the 1980s), and office vacancy is approaching the highs of 1992. Hotels have had a disastrous year (revenue per available room is down over 18%); malls are still wretched investments (and will likely remain so after what is expected to be a poor holiday shopping season); and industrial properties have been hurt by continuing convulsions in the manufacturing sector, shipping and storage sectors. Even real estate such as parking lots, storage sheds, and farmland has been undercut by the recession.

We work primarily in the multifamily sphere, and while we have rued the erosion of credit in the industry (and the fact that taxpayers are now going to foot the bill for the greed of Wall Street and the monetary policy of the Feds), we have very little to complain about in the current recession. Occupancy is generally up, cap rates are rising, and the multifamily housing market is doing well, although overbuilding is now a possibility in some markets.

Things may not be so rosy for people who own retail or office space. U.S. business bankruptcies have increased for 10 straight months, and small businesses are particularly at risk (but sober as they were, they will get no bailouts like their drunk cousins on Wall Street. Mall vacancies are up to 6.3%, the highest rate since 2002. Office is struggling, too; national vacancy is at 14% and may hit 17% by the end of this year, rates seen only twice since 1991. Even subleased office space–generally a sign of a weak economy–is on the rise.

Given the troubles in the office and commercial sectors, it comes as no surprise that a poster child of the recent real estate development binge is on the decline: the the lifestyle center.

Lifestyle developers–like most developers of the past five years–simply got ahead of themselves and the market. They overbuilt and overleveraged in an an era when credit was too widely available and consumer spending was organized around debt. Nothing deterred builders from adding more product to the pipeline.

Given the earthquake in the financial system and its equally strong aftershocks in the economy, that will probably change this year as construction loans come due. And with a brisk economic turnaround looking less likely than experts thought, it may take a while for those empty spaces to fill.

The lessons to learn from the decline of office and retail spaces are myriad, but the most important is diversification. Some cities have experienced almost no decline, especially if we include international cities. Some cities have even seen growth. Some cities have seen losses only in certain sectors.

As is always the case, what investors see is largely a product of where they look.

- Jens Larson, Analyst