NEW YORK (Reuters) - Real estate investors are bracing for the fallout from recession and the Sept. 11 attacks to impact commercial real estate in 2002, following a year when their investments beat most stocks and bonds.
Major real estate sectors -- office, retail and hotels -- already hurting from a weak economy, suffered a severe blow from the attacks which kept people away from work, shoppers away from malls and forced vacation cancellations.
Consequently, there has been an increase in late rent payments and empty office and mall space. And if interest rates rise next year and push up construction cost, the market will struggle, lenders and investors said.
Commercial real estate markets in areas such as New York City and San Francisco, which had been fueled by the stock and high-tech booms, have been hit the hardest. Rents in prime office towers have dropped as much as 25 percent from their market peaks.
``It's going to be a function of interest rates and economic activity,'' said Greg Hauser, chief executive officer at Principal Capital Real Estate Investors in Des Moines, Iowa, which manages $20 billion in assets. ``If interest rates pick up in the first and second quarters, it would have a downward pressure on (business) volume.''
Financial risks related to the Sept. 11 attacks, like the cost to insure skyscrapers, have not been quantified but may pose the greatest challenge when the economy recovers and demand for commercial space goes up.
``With Sept. 11, it confirmed we are in a recessionary environment. It's too early to know the long-term effect on the real estate market,'' said Sam Davis, who manages $9 billion in real estate assets at John Hancock Financial Services in Boston.
The United States has been in recession since March, led by corporations slashing hundreds of thousands of executives, office and plant workers from their payrolls after the burst of the stock market bubble. Investors and lenders have consequently been less inclined to give the green light for construction of hotels, offices and shopping centers.
While the volume of real estate deals has recovered a bit since Sept. 11, investors, lenders and developers are far apart in agreeing on the levels of returns on loans or direct investments for refinancing and new construction.
For example, before Sept. 11, the bid-ask difference on a $20 million downtown office tower would be $1 million, but since then that difference would run in the $3 million to $4 million range.
Despite gloomy forecasts of vacancy and delinquency rates creeping higher, the current downturn would likely be less severe than the supply-glut driven bust in the late 1980s and early 1990s, real estate players said.
PLENTY TO CHEER IN 2001
Despite numerous hurdles in the coming months, commercial real estate players have plenty to cheer about this year.
Real estate investments, whether loans or direct funding, fetched better returns in 2001 than most stocks and bonds. Their stable income attracted investors battered by the wild swings in the equity and fixed income markets.
``Cash flow is addicting,'' said Leo Wells, president of the $1 billion Wells Real Estate Funds based in Atlanta.
Year-to-date, all real estate investment trusts (REITs) -- stocks of property developers and management companies -- have risen 14.7 percent, according to the National Association of Real Estate Investment Trusts, compared with the 15 percent drop of the Dow Jones Industrial average (^DJI - news) and a 21 percent loss in the Nasdaq composite index (^IXIC - news).
Lehman Brothers projected that bonds backed by commercial real estate loans would earn a 10.5 percent return this year, versus a 7.8 percent gain on U.S. Treasuries.
INSURANCE SEEN KEY
With the exception of New York City, which lost roughly 15 million square feet of property in lower Manhattan from the Sept. 11 attacks, new supply of commercial real estate properties next year will be modest.
Developers and their financial backers will seek ample insurance to cover attacks like those that toppled the World Trade Center's twin towers and killed more than 3,000 people, on their new buildings.
``Property developers will pay more attention to their insurance coverage. We are making sure they get the right insurance,'' said Gregory Saunders, chief financial officer at Bridger Commercial Funding, a private real estate finance company based in San Francisco.
But they may have a hard time finding an insurer that will offer such coverage.
``It's not clear what insurance is available and at what price,'' said Principal's Hauser said.
The insurance industry, facing up to $40 billion in claims from the attacks, is clamoring to exclude terrorism coverage from commercial and property and casualty policies.
Reinsurers -- which insurance companies turn to spread their risk -- are already canceling terrorism-risk coverage from Jan. 1, when most contracts come up for renewal.
Reuters Limited By Richard Leong