The Punishment of Capital Invested in Office Buildings in 2010

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Most persons even casually associated with commercial real estate in the 1990's were aware that office space was in a condition of oversupply, and that rates and terms for tenants were more favorable then than they had been for many years. Rental rates in many regions were lower than five years previously, without any adjustment for inflation. Some attention had been paid to how long it would take the inventories of vacant space to be absorbed and at what rates. Of course, the answer depended on the regional market and the health of the economy which supported the local demand for space, but many markets required at least two years without more construction to absorb existing inventories, and some required five years or more. Perhaps a little less attention was paid to how this situation arose, but ease of credit, and the shifting of risk by developers to financial equity partners and lenders was certainly a big part of it. Very little was said about how long the economic consequences would be felt in the office leasing market after absorption of the oversupply, and what those consequences would be.

More significantly, there were lessons learned from the experience of two decades ago that should have been imprinted into the minds of those in the industry, never to be forgotten. But that is clearly not the case. Either they were never learned, or perhaps conveniently discarded when the opportunity to chase potential outsized profits presented themselves again, or a new generation of players who never had been in a war took command of resources. It is never too late for a history lesson, and to take note that those who do not pay attention to history may be condemned to repeat it and learn the agonizing lessons once more. While much is being made of the liquidity crisis occasioned by the meltdown of the capital markets, and rightly so, there is much more to it than just availability of replacement financing. That assumes all commercial office properties are otherwise sound. But clearly, they are not. "Easy money" created an inventory of underlying assets that may not be worthy of debt eligibility, and that makes the problem more deep and complex than just finding a lender to refinance an existing loan that is reaching maturity, and potentially for which capitalization rates have changed a debt/equity ratio that challenges underwriting of the principal balance to lend and the interest rate to charge.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Edwin Reeser, Edwin B. Reeser, A Professional Law Corporation | Attorney Advertising

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