Commercial real estate market still shaking out

December 7, 2009
| By Pete Daly |
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Unlike the residential housing market, which appears to be recovering, it sounds like the "crash" in commercial real estate may be happening right now, in the opinion of John Zevalkink.

"The crash, if you will, or perfect storm, is a little further behind in the commercial (real estate) area," he said, adding that the professional opinions he has heard seem to suggest that "we have yet to see all of the impact in the commercial area."

Zevalkink is CEO of Columbian Logistics Network, a third-party logistics provider based in Grand Rapids. Columbian maintains over one million square feet of warehouse space, much of it leased.

The reaction of commercial real estate to the recession seems to be running six to 12 months behind residential. "I think it's probably because the commercial real estate is owned by investment groups," said Zevalkink. "They're in a position, maybe, to carry some of these products a little longer than an individual with a house," who is having financial difficulties.

Zevalkink concedes his knowledge of commercial real estate is mainly limited to the West Michigan.

While he has seen some companies come in to West Michigan and buy or lease space "at distressed rates," his gut feeling is that the situation here now is “at the bottom. Vacancy rates should show improvement from here. However, it's not going to happen quickly."

Vacancy rates, of course, drive commercial real estate values.

"I think that in the distribution/warehousing market, values are down a good 25 percent," he said, adding that leasing values are down much more than purchase prices.

Zevalkink saw the official 9 percent estimate of the current warehousing vacancy rate in Grand Rapids distributed by Plante & Moran. However, he said that while that may technically be correct, it does not take into account "all the space that's being used temporarily."

In normal times, a warehouse owner may require a five-year lease, but now, whenever a lease comes up for renewal, the lessee can shop around for a better deal among all the vacant properties.

"Because of the condition of the market, the landlord is choosing to get what he can get. So he's got someone in there who has not made any commitment. They're leasing month to month."

That's what Zevalkink considers "temporary" use of space. That same space is available to anybody who comes along and is willing to pay a little more for it when the lease expires at the end of the month.

"Nine percent maybe is the true vacancy rate, but there's a lot more real estate available. Available (warehouse) real estate is probably more like 20 percent" of the total, he said.

Back in the 1990s and earlier, much more of the warehouse space was owned outright by manufacturing companies.

"The amount of space being used by third-party logistics companies like mine definitely has increased. It's growing by at least 10 percent a year," he said, adding that growth has been going on for about 10 years.

The trend has gone the other way for the manufacturing industry, he said, because it is not willing to commit so much of its capital in non-manufacturing processes such as warehousing and transportation.

The third-party logistics business "has become much more sophisticated," he said, involving a significant investment in IT systems and warehouse equipment. So manufacturers are "outsourcing" those functions, said Zevalkink.

The market for commercial space used by third-party logistics companies such as Columbia "has not taken as much of a hit as some of the other commercial space, the office buildings, the manufacturing space, and that kind of thing," in Zevalkink's opinion. He added that some of the new warehouse space put on the market lately by manufacturers is now being used for logistics space.

CoStar Property released warehouse market statistics for the third quarter, covering 15 counties in western and southwestern Michigan. Deliveries of new square footage year-to-date totaled 76,000 square feet out of a total rentable building area space of more than 286 million square feet. And CoStar reports that there is no new warehouse space under construction in the 15 western Michigan counties it reported on.

"You don't need new construction," said Zevalkink. "Nobody's going to put up a new building today."

Five years ago, he said "there were people literally building commercial warehouse structures on speculation that they could fill it up. Or more typically, they would build twice the building they needed, because they had a customer for part of it. Nobody would do that today. And nobody's going to finance it. It's very hard to find money for commercial real estate."

It costs about $40 a square foot to build warehouse space, in Zevalkink's estimation, "and you can buy very solid commercial warehouse space for twenty bucks today. So why build?"

The scarcity of ready financing by the banks is "smart," in his opinion.

"Their liquidity is not good, so they just aren't in a position" to lend readily. "And second, they have gotten burned" in the real estate market during this recession.

"They're not going to get burned again," he said.

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