Is commercial real estate really that bad?

With rising unemployment and falling customer spending hurting both office and retail properties, many pundits have pointed to commercial real estate as the "next shoe to drop" in this difficult economy. According to this argument, losses on commercial real estate will deal a fresh blow to real estate investment trusts (REITs) and the banking system as a contracting economy leaves offices empty and leads to defaults on the borrowings used to finance buildings. However, according to one of the largest commercial real estate holders, market conditions aren't actually that bad.

Boston Properties (BXP) -- which focuses on "Class A" office buildings -- reported favorable earnings on Tuesday, as shares have risen more than nine percent since market close on Friday. This comes on the heels of company Chairman Mortimer Zuckerman's Wall Street Journalop-ed, titled "The Economy is Even Worse Than You Think," in which he used over 1,300 words to argue that economic data underestimates the severity of the crisis and that proposed solutions will be ineffective.

When asked to explain Boston Properties' results in the context of the economy, Zuckerman said, "[I]f you have higher unemployment, you have continued decline in housing prices, and you have a continued constraint on credit in general, I am not optimistic about the economy... I'm in another business, I'm in the publishing business. The publishing business is much worse than the general economy... So when you ask me how do I reconcile the two with our real estate business? Because we're in a unique place in the real estate business and I think that will continue, as it has in the past, to show that we will do better in down markets thus far than a lot of our compatriots in the business."

As Zuckerman went on to explain, Class A properties have different economics than lower-grade units because more businesses look to take advantage of lower rents in a down market to upgrade their location. Boston Properties concentrates on east coast markets between Washington, D.C. and Boston, as well as the San Francisco area. CEO Douglas Linde said that mid-town Manhattan is seeing momentum for leasing office space, San Francisco is solid, and Boston is holding up. The company has more lease renewals it needs to complete in Washington, D.C., but pricing is generally firm there.

The overall theme of the conference call was that quality companies with attractive assets and good balance sheets (Boston Properties recently raised over $840 million in equity) will survive slack economic times and be able to make value-creating acquisitions. In other words, the markets will work as they're supposed to over time, reducing competition and leaving better companies with more opportunities to profit. Nonetheless, that upturn could take a while to arrive.

During his remarks and Q&A, Zuckerman expressed a great deal of concern about credit card losses, noting that those defaults -- not commercial real estate losses, which are a much smaller portion of a typical bank's loan portfolio -- could prevent institutions from lending in other areas. In his estimation, although the capital markets are coming back for commercial real estate, it won't be banks doing the lending: "[T]he banks themselves, I think are going to be out of the market in terms of the commercial real estate for at least as far as I see. I think we're looking at not months, but years."

James Cullen edits and writes at He has no personal position in the stocks mentioned above.

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