Steep cuts in Federal spending that could cut right through to commercial real estate (Diana Olick)

Diana Olick
Link to Diana Olick Site
CNBC
12/1/10

Just when you thought the commercial real estate market was finally on the upswing, new roadblocks to recovery may be lurking right around the corner. President Obama's deficit commission recommended some steep cuts in Federal spending that could cut right through to real estate.

"The commission’s recommendations, if implemented, would be a sizable drag on commercial real estate in the short term as increased taxes and reduced government spending will have a cooling effect on the economy," says Christopher Macke of CoStar Group, a commercial real estate analytics and data service provider.

The most glaring risk is in jobs cuts.

The recommendation to reduce the federal workforce by 10 percent, or 200,000 jobs, would cut the need for office space. It's as simple as that.

"DC's office market fundamentals, in particular, have benefited from growth in federal payrolls and related private sector jobs. Even in other markets, there is some evidence that GSA-tenanted office buildings trade at a premium (tenant credit quality matters a lot these days)," notes Sam Chandan of Real Capital Analytics. "Ultimately, the impact on fundamentals and property values would be concentrated in the one market that would stand to lose a meaningful share of total office space demand, i.e. Washington, DC."

DC surely has the highest share of federal workers, but CoStar estimates it's still only 17 percent of the total 3.6 million employees, so the pain would surely spread outside the district. But then take $100 billion out of defense spending, and you're obviously reducing employment in local markets that are heavily dependent on defense. Much of that is also in DC, and beyond.

Now here's one you might not have thought of: If you scrap the mortgage interest deduction on mortgages over $500,000 (currently it's capped at $1 million), then you reduce consumer wealth, which in turn reduces consumer spending, which in turn reduces retail space demand.

"Eliminating or scaling back this vital housing deduction will shrink the local tax base of many communities, causing already cash-strapped state and local governments to further cut jobs and essential services," adds Bob Jones, chairman of the National Association of Home Builders.

CoStar agrees, pointing to likely inevitable state budget gaps that it says will result from the deficit reduction proposals. Those gaps would force states to cut spending even more (can they possibly??), which would mean more layoffs at the state level and reduced consumer spending, hitting both office and retail. Then, states might be forced to sell off more of the real estate they own, which could reduce commercial prices.

"It is always best to have corporate spending driving the economy, but absent that somebody has to spend," adds Macke.