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
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 firstname.lastname@example.org
or (678) 808-2700.