Commercial Real Estate Slow To Recover In Phoenix

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ARI SHAPIRO, host:

This is MORNING EDITION from NPR News. I'm Ari Shapiro sitting in for Steve Inskeep.

RENEE MONTAGNE, host:

And I'm Renee Montagne. There have been some signs lately that the economy is picking up, including the housing market. But some analysts are saying that commercial real estate market could be the next blow to the nation's economy. One place that's been hit hard is the Phoenix metro area, including Tempe, where empty office space is piling up, rents are falling, and foreclosure notices are on the rise. Peter O'Dowd of member station KJZZ has this report.

PETER O'DOWD: In good times this downtown Tempe street corner would be a pretty good spot for 263,000 square feet of shimmering new office space. But these are not good times in Arizona and this building is skeleton empty.

Through the dusty windows, Nancy Hormond(ph) can see bags of concrete and rolls of insulation propped against unfinished walls.

Ms. NANCY HORMOND: It is not quite completed yet. The building has gone into receivership and it is stalled at this moment.

O'DOWD: Hormond runs a group that promotes business along this trendy avenue bustling with commuter trains and college kids. The building's developer filed for bankruptcy in July, and the longer it stays empty the longer Hormond worries about the perception of future tenants.

Ms. HORMOND: When they get off the light rail and they see all this empty space, their perception - what people are thinking - is that, oh my goodness, there's nothing going on down here.

O'DOWD: This scene repeats itself all across the greater Phoenix area. The National Association of Realtors predicts 26 percent of all the office space in the region will go empty in the third quarter. That's the worse vacancy rate in the country. And it's 10 percent higher than the national average. Lease rates have also fallen and new foreclosure notices hover at around 400 a month.

Dan Mercer has followed commercial real estate in Arizona for three decades, and he says the roots for this collapse were planted with the housing boom in 2006.

Mr. DAN MERCER: We had the best growth in the United States. Housing was great. Employment was off the charts. Everybody was on the bandwagon. Now, we're facing that overhang that was created when things were going quite well.

O'DOWD: In other words, Phoenix overbuilt strip malls and office towers as much as it overbuilt housing. Mercer and other local analysts say the commercial market will get worse before it bottoms out. Still, Mercer remains optimistic.

Mr. MERCER: We all understand that given time real estate will cure itself. What value it will be at the other end of the curve is unknown.

O'DOWD: The other end of the curve. That's where all eyes are looking. Las Vegas, South Florida, California and other areas slammed by the housing crisis face similar problems in the commercial market.

So now what? Just as the economy shows some signs of recovery, the question is whether or not this will be the next crippling blow to the financial system. Janet Yellen is the president of the San Francisco Federal Reserve Bank. In a recent speech, she warned of the coming danger.

Dr. JANET YELLEN (President, Federal Reserve Bank of San Francisco): The next area of significant vulnerability for the banking system is income-producing office, warehouse and retail commercial property.

O'DOWD: But is that potential crisis going to be as bad as the housing meltdown? Brian Bethune doesn't think so. He's the chief U.S. economist for IHS Global Insight, a forecasting company that analyses financial markets. He says the scale is totally different. Outstanding debt in the housing market is near $10 trillion. Commercial debt is closer to $3 trillion.

Mr. BRIAN BETHUNE (Chief U.S. financial economist, IHS Global Insight): It's a difficult cycle, but I don't think it's anywhere near - anywhere near the same proportion as the problems we've had on the housing side.

O'DOWD: Bethune says the commercial real estate crash will still hurt and the fed will have to keep an eye on banks as they bear the next round of losses, which may be somewhere around here.

A few blocks south of the empty office building on Mill Avenue, Blair Mackey sits in the shadow of a massive condominium complex that was abandoned when the developer went bankrupt. Mackey has managed a nearby cigar shop for three years and says by now he's used to staring up at the empty giant.

MR. BLAIR MACKEY (Manager, cigar shop): For all of us that are down here daily on Mill Avenue it doesn't seem weird anymore. It's just - it's a reminder of how things were and hopefully they'll get it fixed quickly.

O'DOWD: The development is 52 stories of residential and retail space. And in this market, a quick fix may not be possible. In fact, any fix at all may still be a long way off.

For NPR News, I'm Peter O'Dowd.

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