MorrisAnderson

It’s been nearly five years since the housing market began its decline and two years since the recession was officially declared a thing of the past. In many parts of the country, real estate markets are well on their way to recovery. Arizona, however, is not one of them. For those in the Grand Canyon State, a long wait still lies ahead. To survive that wait, business tenants, landlords and lenders will have to embrace the spirit of cooperation, working together to make it through.

Explosive Growth and Devastating Decline
From 2000 to 2010, Arizona’s population increased 24.5 percent, making it the second-fastest-growing state in the nation, according to U.S. census data. As in other “sun belt” states, the influx of residents brought heavy demand for real estate, spurring construction and boosting prices in both the residential and commercial markets. In 2004 alone, the average price per square foot for office condos in Scottsdale and the south East Valley area jumped $10, according to CB Richard Ellis.

But, when the bubble burst, Arizona’s real estate market came down swiftly and dramatically. Once demand was satisfied, prices dropped, and new mortgage holders found their properties were no longer worth as much as their outstanding loans. In April, one in five Phoenix-area mortgage holders would have needed property values to at least double just to break even, Bloomberg reported.

Construction ground to a standstill. The number of new single-family construction permits in the state dropped around 30 percent each year from 2004 to 2006 before plummeting 49.2 percent from 2006 to 2007, according to W.P. Carey. Many commercial development projects were simply halted, with cranes left to stand amidst unfinished shopping centers or office parks.

A Long Road to Recovery
Recovery for Arizona will likely take even longer than analysts previously expected. A University of Arizona economist, Marshall Vest, who had previously forecast relatively strong economic improvement, told the Arizona Republic in March that he now doubts recovery will come before 2015. Based on our experience in the market, that seems reasonable.

The two major problems standing in the way of recovery are slow job growth and lenders’ reluctance to provide financing for secondary assets.

For June, Arizona’s unemployment rate was 9.3 percent, only a tenth of a percent above the national average but still troublesomely high. Slow job growth has retarded the absorption of the excess capacity generated during the boom, allowing supply and demand to remain out of balance. Without new hiring, businesses have little reason to expand their real estate footprints. In the Phoenix area, the vacancy rate for office space in 2010 was an astounding 26.2 percent. Vacancy rates for industrial, retail and residential space were also high, though somewhat lower, at 14.7 percent, 12.2 percent and 10.3 percent respectively.

Limited lending has also retarded the rebalancing of supply and demand by keeping the volume of transactions low, preventing excess capacity from being absorbed. While financing has loosened some for prime assets such as Class A multi-family and office properties in select cities, activity in Arizona, as in other less attractive market and regional sectors, remains stymied.

Working as Partners to Adapt
Until there are significant increases in job growth and lending, Arizona businesses will continue to exist in a post-collapse reality. Companies that hope to survive need to develop effective strategies to deal with that reality.
In a real estate market under pressure, many people are inclined to see the relationships linking tenants, landlords and lenders as battlegrounds in a zero-sum game. But as much as their interests may seem to be in competition, these parties are also held together by bonds of mutual dependence.

A landlord can refuse to accommodate struggling tenants’ needs, but, if it does so, the tenants may be forced to leave, creating hard-to-fill vacancies. When landlords go to lenders for concessions, the lenders, too, have the option of holding to original terms but are better served by compromise. Since real estate values in Arizona have dropped so precipitously, lenders who repossess a property are frequently left with inventory that is worth less than the balance of the loan. Ending relations with the borrower means either accepting that loss or entering into a lengthy process to extract the remaining balance. Negotiating, on the other hand, allows the lender to retain the possibility of eventually recouping the investment.

In looking at the Arizona market, we have observed that businesses that were up and running before 2005 or 2006 have fared far better than those that were still breaking ground when the crisis hit. We believe relationships between tenants, landlords and lenders were a significant factor in more established companies’ greater success. Those businesses that had time-tested foundations to rely on were better able to negotiate when their situations changed.

The time invested in building relationships is only useful, however, if it is spent establishing trust. It is essential for all parties to be straightforward in their conduct. As soon as a landlord loses faith in a tenant or a lender loses faith in a borrower, the parties’ ability to work together to find mutually beneficial arrangements disintegrates.

Of course, trust is not always enough. Even borrowers with strong relationships with their lenders are sometimes unable to negotiate, as banks implement comprehensive strategies to improve their portfolios. The fact that, according to RealtyTrac, a record 2.9 million U.S. properties received foreclosure filings in 2010 testifies to that. Of those properties, 155,878 were in Arizona, giving the state the nation’s third-highest number.

Still, the best advice for those waiting for recovery in Arizona is to work together. Eventually, job growth and increased lending may bring new stability to the Arizona market. But, until then, whether they want to or not, tenants, landlords and lenders need to act as partners.


Josh Joseph is a Founder and Principal of Frontline Real Estate Partners, based in Northbrook, Illinois. He has executed real estate transactions, both acquisitions and dispositions, in almost every state within the continental United States. He has disposed of over $500,000,000 of real estate and has acquired over $100,000,000 of real estate during his career. Josh’s clients include publicly traded companies, privately held corporations, private equity companies, financial institutions, retailers, court-appointed trustees and receivers, and traditional institutional and private real estate companies. Prior to Frontline, Josh spent eight years at Hilco Real Estate as a Senior Vice President. Josh is a licensed Real Estate Broker in the State of Illinois and can be reached at jjoseph@frontlinerepartners.com.

 

Tim Shaffer, CTP, CIRA, is a Director at MorrisAnderson. He has more than 26 years of experience in business and real estate finance. Tim serves on the Board of Directors and is Program Chairman of the Arizona Chapter of the Turnaround Management Association (TMA). He has served the complete spectrum within the bankruptcy environment, representing Chapter 11 Debtors-in-Possession, Unsecured Creditors Committees, Chapter 11 and Chapter 7 Trustees. Tim has been a licensed real estate associate for 20 years and has placed over $100,000,000 in commercial real estate mortgages. He can be reached at tshaffer@morrisanderson.com.