Do The Tenants Know The Recession Is Over?

Economists Say Recovery Started 15 Months Ago, But Brokers Say Tenants Are Still in the pre-June 2009 cycle and a long way from the pre-recession years.

The National Bureau of Economic Research — the official referee of the economy — announced this week that it determined that the recession ended and economic recovery began 15 months ago in June 2009. However, according to commercial real estate service providers, economic conditions for most American tenants are still in the pre-June 2009 cycle and a long way from the pre-recession years.

Smith System in Arlington, TX, the nation’s first professional fleet driver training company, is representative of the current tenant mindset. When the economy is expanding, the need for freight drivers increases. When it is not expanding, Al Caldwell, senior vice president of operations and international sales for Smith System, sees no need to expand either.

“Our business would have to increase 20% to return us to 2008 levels,” Caldwell said. “We have the same staffing we had in 2008 and don’t see any need to increase for probably two years or more.”

And when it is time to expand, that still won’t translate in the need for more space. During the prolonged recession, Smith System has mothballed space, as many businesses have.

“We have approximately 10 unused spaces that we could use if we were to expand,” Caldwell said. “We think our return to 2008 levels will require two more years, so, that fact, combined with the extra space we have, probably means we are at least three years or perhaps even longer away from needing more space.”

That is the message that many commercial real estate brokers are getting across the country, too.

“Many mid-size and smaller companies are afraid of the possibility of a double dip recession. They are unconvinced that the recession is really over, despite the statements by several so-called economic pundits that the it “technically” ended in June 2009,” said Howard Applebaum, president of Corporate America Realty & Advisors, a tenant rep firm in Rutherford, NJ. “Until we see greater access to financial liquidity and greater financial leverage for business and real estate borrowings, companies will remain conservative and avoid adding staff. What must be feared here is that without the capability of loosening the credit restrictions that banks have placed, it can lead to further staff reductions as companies that do not have access to “Wall Street” capital will burn through their cash holdings.”

Scott Abernethy, senior vice president of Cassidy Turley in Cincinnati, OH, said 90% of the companies they talk with are not hiring.

“Companies in the past two to three years have downsized and extended their leases; these companies do not have excess space,” Abernethy said. “However, many firms with leases farther out in the future have excess space that they can’t unload. If the economy improves, they feel they can backfill that excess.”

The other problem, Abernethy said, is that the responses to the recession have made it harder for tenants to know what expansion might cost them.

“The good news is that they are no longer cutting staff, but most companies feel like they can’t expand because they just don’t know what new employees will cost,” Abernethy said. “There is a large amount of confusion as to health care, employee benefits and taxes, and companies just can’t project their future costs of doing business. Once government policies are understood by the businesses, they will then know what they are dealing with, and will start expanding.”

While the brokerage community generally feels that the bulk of staff downsizing is past, that doesn’t mean that firms are finished cutting costs.

Chris Fountain, business development manager / sales for relocation firm Suddath Office Solutions in Jacksonville, FL, says the businesses they deal with are now adjusting their space needs to accommodate their past staff reductions.

“Most businesses have adopted the practice of adjusting the size of their labor force and physical space to cope with current economic changes. So, it has become a way of life,” Fountain said. “Many businesses are still in the mindset of reducing their operational overhead expenses by reducing their square footage. Many of the large corporations we deal with have more than enough space and could prolong new demand out at least a couple years depending on what happens.”

Bradley D. Larson, vice president of Partners National Real Estate Group in Dallas specializes on the industrial side.

“Since distribution and logistics users tend to be more focused on square footage and the respective economics, we have seen an emphasis from our industrial clients on right sizing their branches,” Larson said. “We are still seeing smaller and less productive branches close as the lease expirations loom closer. This is happening at a lower rate than before, but is still somewhat prevalent in tertiary markets where market demand for our client’s products is not keeping pace with fixed costs. So, as opposed to downsizings, it is more common for our industrial clients to consolidate or close a branch than to lay off staff.”

“Since leases have, by nature, expired during the downturn, those lease renewals have (whether knowingly or unknowingly) locked in lower rental rates and thus have prepared a lower fixed overhead position for our clients in the years to come,” Larson said.

Mike Fransen, vice president and asset manager for Parkway Properties Inc. in Houston, is seeing the same thing on the office side.

“I think we’re still working our way through. We still have a fair number of people that signed at the peak of 2006-2007 that are coming up on renewals and many will likely have their first opportunity to downsize,” Fransen said. “So I still envision that continuing for a little while, certainly into 2011.”

“There is lots of grey (sublease) space still diluting and complicating the leasing environment here in Houston. It is does impact leasing decisions by companies,” Fransen added. “It has killed large deals we’ve worked on. When the CFO realizes he has unused space in his existing portfolio, he decides not to sign that new lease. Added to that are new and empty new assets, and that combines to make for a sloppy office environment for a while. With jobs very slow to come back nationally and locally, it’s impossible to tell how long this continues.”

It is a very pessimistic outlook, said Kenneth W. Colwell, senior leasing and sales associate of Paragon Real Estate Group in San Francisco.

“My feeling is true recovery will not occur until unemployment and sentiment/confidence returns,” Colwell said. “Only users who are recession-proof will expand or relocate, that includes medical and government, with startups looking for rock bottom subleases deals.” (credit m. heschmeyer-costar)