Friday Letter Brokering a bifurcation

The backing of only the strongest property owners by tenants and brokers – due to concerns over the health of potential landlords – is leading to a split in US property markets between the healthy and weak. 

The problems facing US landlords today can be boiled down to two issues: income and capital.

In a commercial property market still searching for bottom, vast numbers of investors are experiencing real challenges when it comes to rental incomes, as vacancy rates rise to levels not seen for almost a decade. Many more are struggling to come to grips with their capital structures after debt markets largely seized, pushing up the cost of available capital under much stricter terms. Indeed, some landlords are having to deal with both issues at the same time.

These tensions are issues limited partners in private real estate funds are acutely aware of. However, so too are tenants and brokers, according to NAI Global, winner of PERE’s global broker of the year award.

In an industry where institutional investors are choosing their future investment partners on the basis of their income and capital health, tenants and brokers are also turning against “weak” property owners who bought at high prices with high levels of leverage, and are now struggling against rising vacancy levels, unable to meet their mortgage payments and are running out of reserves to cover new leasing costs.

“Mostly these buildings are known,” said Andrew Simon, executive managing director at NAI Global, speaking at the firm’s global economic outlook breakfast in New York earlier this week. In New York City, in particular, Simon said “savvy tenants and savvy brokers” were steering deals “towards the strong landlords”, predicting that in a short period of time, the city’s property market would see “very dramatic changes in the difference in vacancy rates between strong ownership and weaker ownership, perceived weaker ownership, unknown ownership”.

With vacancy rates topping 12 percent in New York City in the final three months of 2009, from around 5.5 percent in the third quarter of 2008, and average asking prices continuing their downward trajectory, the balance of power is certainly in tenants’ and brokers’ favour.

This emerging bifurcation of the rental market will add even more pressure to landlords trying to keep their heads above water.

But it could also impact a wider-swathe of landlords who bought in recent years, as tenants and brokers target long-term property owners – not least New York’s traditional real estate families and REITS – as one potential source of deals.

It will now be down to younger investors and landlords, including some private equity real estate firms, to actively separate themselves from this bucket of “unknown ownership” by proving their income and capital health.