How to navigate Atlanta’s shifting commercial real estate market Featured

11:51am EDT November 1, 2010

Smart Business spoke to John M. Leonard, the first vice president

and regional manager of the Atlanta office of Marcus & Millichap Real Estate

Investment Services, about where opportunities lie in the distressed real

estate market.

How high is the level of

distress in the Atlanta commercial real estate market right now and what does

it mean to investors?

Weak economic conditions

through the recession took a toll on commercial real estate fundamentals in the

Atlanta metro area, leading to a significant amount of distress. Approximately

$5.1 billion of real estate in Atlanta can be classified as distressed, placing

it near the center of the pack when scaled to the market’s size and compared to

other major metros nationwide. The distressed dollar volume total includes

approximately $3.4 billion in troubled properties and another $1.7 billion in

assets already reclaimed by banks. The figure does not include, however, the

roughly $650 billion in commercial mortgages that has been restructured or

extended, or the $1.3 billion in distressed commercial real estate deals that

have already been resolved.

Which sector of the

investment real estate market has been impacted most by these delinquencies?

As of third quarter,

apartments account for the largest share of distressed dollar volume in the

Atlanta metro area, which should translate into some strong acquisition

opportunities for investors as fundamentals recover. Interest in stabilized

lender-owned properties remains particularly high, and several sales involving

this type of asset have already occurred. Prices for these deals generally

start below replacement costs at less than $40,000 per unit, with cap rates

varying from 8.5 percent to 9.0 percent. Assets with deferred maintenance or

high vacancy also continue to attract interest due to opportunities to

strengthen performance in the quarters ahead, but cap rates typically will

begin above 9 percent. While the expected improvement in occupancy and rents

will bolster NOIs, new supply will slow through the remainder of this year and

into 2011. The slowdown in construction will provide greater opportunity for

new owners to rebuild property operations.

How have delinquencies

impacted the retail real estate sector?

While investor demand remains

greatest for stabilized retail properties occupied by strong tenants with good

credit, the market for distressed deals has become more active. More lenders

have begun to list distressed shopping center properties in the Atlanta metro

area, a trend likely to persist over the remainder of this year. So far, even

vacant retail assets have attracted interest from local buyers, although prices

must be approximately $40 per square foot for deals to occur. Distressed sales

will likely continue to appeal mostly to local private investors, as the

majority of the retail properties classified as REO as of the third quarter are

relatively small, with an average size of approximately 33,000 square feet. 

How is the office market

performing and how much duress is that sector under?

Office property operations

have continued to soften this year due to the completion of substantially

vacant properties in the urban core and continuing business closures and tenant

downsizings. Properties scheduled for delivery this year broke ground during

better economic times but will expand office stock by a significant 1.9 percent

at a time when demand remains slack and vacancy already exceeds 20 percent.

While gradual strengthening in the local economy will lead to the creation of

approximately 7,700 office-using jobs by year-end, many of these positions will

fill underutilized space before tenants contemplate enlarging their footprints.

Efforts by property owners to

fill vacancies as demand improves and leases roll over will sustain the

downward trend for rents, placing additional pressure on NOIs and contributing

to more distress in the local market. Although fundamentals will remain weak

for several more quarters, prices have likely neared the bottom. As a result,

investors seeking discounted value-add opportunities ahead of a robust recovery

likely will step up activity in the months ahead. REO activity is also on the

rise, and banks will dispose of more reclaimed assets as their balance sheets

improve. These lender-owned assets, which may be priced at deep discounts, will

present opportunities for aggressive investors to enhance value through the

employment of re-tenanting strategies, including steep rent cuts.

John M. Leonard is a first

vice president and regional manager of the Atlanta office of Marcus & Millichap Real Estate

Investment Services. Contact him at john.leonard@marcusmillichap.com

or (678) 808-2700.