Home Mortgage Mayhem Seeps Into Office Sector

The mortgage meltdown is hitting both homes and workplaces now.

An expanding crisis in residential lending is putting the squeeze on office landlords in some locales across the country as financial service firms and mortgage lenders downsize or shutter operations. A subsequent rise in vacancies has weakened a property sector that has enjoyed robust rent growth to date.

Amid a tough financing climate and worries about slowing employment, many would-be office sellers pulled their properties off the market late last year. They hoped to relist this year and fetch a better price. In Southern California, Arden Realty took five of six office buildings off the block. In Chicago, Principal Financial Group (NYSE:PFG PRB) (NYSE:PFG) PFG pulled back the Quaker Plaza high-rise. Landlords in several other cities such as Boston, Kansas City, Mo., and Winston-Salem, N.C., have followed the same script.

Now a souring economic outlook may force sellers to delay a return to the market, according to Bob Bach, senior vice president of research at commercial property brokerage Grubb & Ellis (NYSE:GBE) , in Santa Ana, Calif.

"It looks like we're much closer to a recession now than we were just a few months ago," he said. "The credit markets are still screwed up, so there's still a gap between buyer and seller expectations."

One area of the economy being watched closely is employment: Job creation stood at 115,000 in November but plummeted to 18,000 last month. The fewer new workers, the less need for office space.

Deteriorating fundamentals could convince sellers to accept lower prices, reinforcing the emerging office buyer's market, Bach says.

The latest numbers indicate a hint of erosion. Nationwide, office vacancies increased 10 basis points to 12.6% in the fourth quarter over the third, according to New York-based Reis Inc. (NASDAQ:REIS) , a commercial real estate data cruncher.

Change In Direction

Far from a significant shock to the system, the slight uptick nevertheless represented the first rise in office vacancies in four years, according to Sam Chandan, Reis' chief economist. More telling, net office absorption -- a measure of leasing activity that compares occupied space at the end of a period vs. the beginning -- dropped from 16.2 million in the third quarter of 2007 to 4.4 million square feet in the fourth.

Layoffs or outright business failures in the financial services and mortgage industries are softening office fundamentals even more in Southern California, Chicago, Minneapolis, Dallas and other areas. Financial service and mortgage companies announced more than 153,000 job cuts in 2007, a threefold increase over 2006, according to Challenger Gray & Christmas, an outplacement consulting firm based in Chicago.

Orange County Woes

The home-mortgage fallout has hit California's Orange County the hardest. Office vacancy climbed to 10.7% in the fourth quarter of 2007, a year-over-year increase of three percentage points, according to Reis. The county is home to several downsized or defunct mortgage and subprime lenders, including Countrywide Financial (NYSE:CFC) CFC, real estate investment trust Impac Mortgage Holdings (NYSE:IMH PRB) (NYSE:IMH PRC) (NYSE:IMH) IMH and bankrupt Ameriquest Mortgage.

All told, those companies and others vacated some 2 million square feet in Orange County over the last several months. Meanwhile, office buildup has occurred, and much of it speculative. Developers added about 2.8 million square feet to the market in 2007 and prepped nearly 900,000 additional square feet for 2008 completion, Reis says.

Those events happened against a backdrop of flat job growth in the county, a departure from historical growth of roughly 1.5% to 2% a year, says Delores Conway, director of the University of Southern California Casden Real Estate Economics Forecast.

"We haven't seen the worst yet," she said. "It's going to be a challenging year, but the market's not going to fall off a cliff, either."

Conway predicts that a resilient and diverse economic base aided by an unemployment rate of about 4% -- an increase of about 80 basis points vs. a year ago but still below the nation's 5% unemployment rate -- should begin to lead the county out of the slump in 2009.

But a study released Thursday suggests a general weakening of Southern California's office space market is likely through 2010. The Allen Matkins/UCLA Anderson Forecast outlook sees Los Angeles faring more favorably than Orange County and San Diego.

"While new office space stock from projects already underway comes onto the market, the weak housing sector and the contraction in the home mortgage and residential real estate industries is having a negative impact on demand," said UCLA Anderson Forecast economist Jerry Nickelsburg in a statement issued with the forecast.

Shareholders in Los Angeles-based Maguire Properties (NYSE:MPG PRA) (NYSE:MPG) MPG, a REIT that owns about 21 million square feet of office space in Southern California, aren't patient enough to wait out the doldrums. The landlord's Orange County vacancy increased 13 percentage points to about 21% in the third quarter of 2007 from a year earlier. Bankrupt subprime lender New Century Financial (OOTC:NEWCQ) was supposed to occupy space in a building Maguire recently completed, which accounted for some of the increase.

Maguire's share price has plummeted some 46% over the last year. Under pressure from shareholders, the company is now exploring alternatives to enhance shareholder value, including a possible sale. Maguire CEO Robert Maguire has said he'll bid for the company.

Spreading Pain

Landlords beyond Southern California are feeling the pinch, too. In Dallas, financial services firms and mortgage lenders such as Morgan Stanley (NYSE:MS) MS, Countrywide, Bank of America (NYSE:BAC) BAC and Capital One's (NYSE:COF) COF Greenpoint 13ortgage subsidiary have cut about 2,000 jobs through layoffs or business closings. Those actions increased sublease space in the market to 5 million square feet over the second half of 2007, the most available since 2004, according to Grubb & Ellis.

In the northwest suburbs of Chicago, layoffs, bankruptcies and closings among seven mortgage lending firms pushed the office vacancy rate up more than 100 basis points to 23% in 2007, and the market experienced negative net absorption of 370,000 square feet. That much more space coming onto the market than was rented indicates sluggish leasing activity.

"The big wave of mortgage companies ceasing business and vacating large amounts of space is likely slowing," said Simone Schuppan, a research manager with Grubb & Ellis. "But the outlook is bleak. There is little interest from tenants to expand or move in."

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Home Mortgage Mayhem Seeps Into Office Sector