Commercial real estate's looming crisis and Architecture 2030's renovation solution

Washington High School, photo by Brian Libby 

Since America's economy was gravely threatened by the mortgage crisis that caused stock markets to plummet in late 2007, we have come a long way back to stability. But the crisis may not be over yet.

The economic storm of the last two to three years was fueled before largely by home foreclosures. But commercial real estate transactions have dropped a staggering 90 percent since 2007, and because commercial real estate (CRE) loans typically have three to ten-year terms, between now and 2014 approximately $1.4 trillion in real estate property loans will come due and require new financing. Many of these loans were originated in the commercial boom years of 2005-2007 when property values were exceptionally high; since then, commercial property values have fallen more than 40 percent, resulting in higher loan-to-value (LTV) ratios. As a result, building owners will have difficulty refinancing, even if their property is performing well. 

Commercial vacancies also continue to increase. In addition, the construction industry has lost over two million jobs, including 35,000 last month, mostly in the commercial sector.

To restore credit capacity and liquidity in the commercial real estate market and create an estimated 1.3 million construction-related jobs, Architecture 2030 recommends implementing what the nonprofit calls the "CRE Solution", a three-year commercial building tax deduction for meeting the energy reduction targets of the 2030 Challenge.

Architecture 2030 was established in response to the global-warming crisis by architect Edward Mazria in 2002. The nonprofit's mission is to rapidly transform the US and global building industry from the major contributor of greenhouse gas emissions to a central part of the solution to the global-warming crisis.1

Besides creating  1.3 million jobs, the CRE Solution claims it will increase after-tax cash flow and property values, and reduces loan defaults; increase commercial real estate investment value and CRE sales (narrowing the gap between the bid and ask price of CRE property); decrease building energy consumption, greenhouse gas emissions, and operating costs; and generate billions of dollars in federal, state, and local tax revenue.

How will this be accomplished? By focusing on energy efficiency renovations and additions.

Graph/image courtesy Architecture 2030 

"This market tends to be less responsive to economic changes than the new building construction market, which is more volatile, responding to the ups and downs of the economy," the CRE Solution white paper reads. "In contrast to new buildings, the value of commercial renovation has remained fairly constant throughout the recession. Over the past five years, from 2005 through 2009, commercial building renovations and additions have averaged $73.4 billion, totaling $69.1 billion in 2009. This provides a substantial existing and stable market for incentives, since it is much easier to conduct additional renovation work and add new space when construction is underway than it is to initiate new construction work."

As it happens, here in Portland there is already some evidence of a move toward renovation in the commercial real estate market. Nathalie Weinstein reports in Monday's Daily Journal of Commerce on efforts by prominent developers like Art DeMuro of Venerable Properties, Brad Malsin of Beam Development and Mark Edlen of Gerding Edlen all targeting rehabs over new construction. Although that has always been the stock and trade of Malsin and DeMuro, the system could be set in place for more renovations.

Weinstein reports that DeMuro has been trying to restore and transform the former Washington High School in Southeast Portland, built in 1906:

"Mired in budgetary woes, Portland Public Schools, which owns the building, doesn’t have the school’s redevelopment high on its agenda. And possible funding from Portland Parks and Recreation to remake the school into a community center died with a decision by Parks and Recreation to not pursue a bond measure this year. Developers who have tried to turn the school into housing in the past abandoned the efforts once they saw the price tag."

"Still, DeMuro won’t walk away from Washington High. The desire to see the building brought back into the community is too strong, he said. 'After I worked on another renovation at in the neighborhood, I felt this connection to the place where Washington High is located,' DeMuro said. 'I’ve never done a school rehab. The project doesn’t have a high probability of a successful conclusion, yet it could have so much community impact.'”

As I've said before, the Portland Institute for Contemporary Art would seem to be an ideal anchor tenant for Washington High School. The organization already staged most of its internationally renowned and locally popular Time-Based Art Festival in the building last year, and will be doing so again this fall. Why not devote a portion of Washington High to PICA exhibit and performance space and designate the rest for some combination of retail, residential and/or commercial tenants? Wouldn't a lot of creative-industry businesses like to locate themselves next to a highly valued organization like PICA?

Olympic Mills Commerce Center, photo by Brian Libby 

The example of building rehabs as hives for the creative industry already has enjoyed success in Portland, with examples like the Leftbank Project on NW Broadway, Malsin's East Bank Commerce Center and Olympic Mills Commerce Center in the Central Eastside, and the Ford Building in Southeast, all of which are healthfully full of tenants during this "Great Recession" or "Great Reset".

As Architecture 2030 notes in the CRE Solution paper, providing incentives to encourage energy reductions in commercial buildings is already established in legislation. The Energy Policy Act of 2005 provides a well-established mechanism for immediately and effectively implementing expanded incentives and energy reduction targets in the commercial real estate market:

"Currently, the Act provides up to $1.80 per square foot for specific energy reduction targets in new and renovated commercial buildings. However, the Act can be amended to better align with the 2030 Challenge and current federal policy, as established in the American Clean Energy and Security Act (H.R. 2454) passed by the House and the American Clean Energy Leadership Act (S. 1462) passed out of the Energy and Natural Resources Committee in 2009, by expanding and increasing the existing energy-efficient commercial building tax deduction provision from $1.80 per sq.ft. to a range of $4.50-$9 per sqare foot for renovations and $3-$7.50 per sqare foot for new buildings (for three years) when meeting the energy reduction targets of H.R. 2454 and S. 1462. This would provide an effective tax benefit for building purchases, renovations, and high-performance new buildings and additions, as well as significant energy savings for businesses and commercial property owners."

Comments

[gerrrg]

First leg to fall: the build up of mortgage resets that will peak in September of next year. Over a $1 trillion dollars of mortgages resetting through 2012. Credit markets are most certainly going to tighten, as people walk away from their under water properties and banks' capital ratios sink, let alone shareholder ratios.

Second leg to fall: Austerity measures here and globally, that will undercut growth and exacerbate credit defaults. Cutting off unemployment will accelerate use of credit, and the subsequent credit defaults. Personal debt will accelerate and unemployment will jump as GDP shrinks. NYT has an excellent article on what happened to Ireland after they responded quickly to the fast-growing debt in 2007-2008.

At that point, this great idea will become moot.

Politics have ensured that no further bank bailouts will occur, therefore a cascade of bank failures will have no backstop.

Yes Mr. Libby, things can get a lot worse than October 2008, and this brilliant idea that would otherwise work in a shallow recession, will barely survive, if at all, as local government retrenches in spending.

Paul Krugman is already citing a Third Depression, although technically, this will be the US' fourth, but most people only count the Long Depression and the Great Depression.

Good luck to everyone in the next 2 years.

[Peter Chapman]

On behalf of Architecture 2030, thank you to Portland Architecture for helping to raise awareness about the CRE Solution.

The U.S. economy has only just begun to feel the impacts of the commercial real estate crisis currently underway. Fortunately, this $1.4 Trillion economic meltdown can be avoided.

With an increase in the CRE energy reduction tax deduction outlined the Energy Policy Act of 2005, the CRE Solution will:

* Create 1.3 million jobs, quickly and cost-effectively,
* Increase after-tax cash flow and property values, and reduce loan defaults,
* Increase CRE desirability and investment value,
* Increase new CRE sales (narrowing the gap between the bid and ask price of CRE property),
* Decrease building energy consumption, greenhouse gas emissions, and operating costs, and
* Generate billions of dollars in federal, state, and local tax revenue.

A detailed summary of the CRE Solution, as well as the full report, can be accessed here: http://www.architecture2030.org/cre/theCREsolution.html.

Peter Chapman, Architecture 2030