Few tenants vacate space in a time of crisis with the fanfare that surrounded Circuit City, which celebrated last Christmas with a massive merchandise liquidation before leaving 15 local big-boxes empty.

Most tenants disappear quietly. There’s a late rent payment, followed by a landlord’s unanswered phone call. The security guard reports a moving truck in the parking lot in the middle of the night.

No matter how it happens, the fallout is always the same: vacant space. And in the current economic climate, vacant space is becoming an increasingly scary thing for North Texas commercial real estate owners.

It’s a big change from 2008, when there was some hope that Dallas might withstand the economic crisis relatively unscathed. But at a recent meeting of the North Texas Commercial Association of Realtors and Real Estate Professionals, it was clear the mood had changed.

The moderator opened the event by asking the crowd if they were glad to be in Dallas these days—a line that drew applause and hoots. The panel that followed, though, was a more sobering reiteration of what everyone in the industry seems to be confronting: emptier buildings, fewer lease deals, and a skittish property-transaction market egged on by expensive lending, uncertain valuations, and anxious investors holding onto their cash.

The question is no longer whether the crisis is going to bypass Dallas; it’s how hard it will hit here. How high will vacancy rates rise? How will poorly performing properties find the credit to get them through the crisis? And how will the combination of increasing vacancies and vanishing credit affect the value of commercial real estate investment?

Lagging Behind the Recession
The hope by some that commercial real estate would dodge the downturn overlooks how the property markets typically function in a recession, says David Lei, a professor at Southern Methodist University’s Cox School of Business.

Real estate lags other industries in hard times, Lei says. Real property supply can’t react quickly to decreasing demand and, when it isn’t needed, supply doesn’t simply disappear. “By the time the concrete is poured, the superstructure [of a recession] is already there,” Lei says. “You build up supply unintentionally.”

That’s what happened with office buildings during the savings and loan crisis in the late 1980s. Lei sees some of the same indications of oversupply today, only this time with retail and multifamily properties.

 “You’ve got a glut coming on line in Uptown and Frisco,” he says. In multifamily, “you want a 2 to 3 percent vacancy rate. What you are finding is closer to a 6 or 7 percent rate.”

But oversupply represents just part of commercial real estate’s exposure. All product types are impacted by the contracting wider economy, Lei says. Apartments in Dallas are fed by corporate relocations and expansions and by new graduates with new jobs moving out on their own. Retail is fed by rising consumer demand for commercial goods—but that demand is shrinking. Office buildings need business growth. Even Dallas’ typically strong industrial market is at risk.

“You look at the feedstock industries, trucking and rail, and there is lower load volume by car,” Lei says. “In some small towns they have lots of empty rail cars sitting on the tracks. This suggests excess capacity in the transportation business.”

Such observations are supported by a recent study by Dallas Federal Reserve economist Roland Meeks. Meeks studied the impact that prolonged tightening in the credit markets may have on commercial real estate.

The economist points to a variety of indicators that suggest tougher times are approaching. While the amount of unoccupied commercial space remained near its historical average in the third quarter of 2008, vacancy trended upward, while rents moved down. Real prices of both office and retail buildings are in decline, Meeks says, and charge-off and delinquency rates on commercial bank loans were up sharply in the third quarter of 2008.

These three indicators work hand in glove. As vacancy increases, properties struggle to maintain cash flow. Desperate owners may look to unload the property on the open market, but those unwilling to trade at a discounted rate look for credit to keep the property afloat.

The trouble for owners and banks, Meeks writes, is that the crippled credit markets don’t seem able to absorb this increasing demand for credit because the commercial mortgage-backed securities market has all but evaporated.

“Banks are less willing to extend new credit when they can’t securitize loans,” Meeks writes. “Buyers are likely to find that mortgages have become expensive or even unavailable, which crimps demand for commercial real estate and reduces the number of transactions.”

In other words, similar conditions that brought down residential real estate—the disappearance of credit combined with an increase in distressed borrowers—may lead to a similar sharp deflation of the commercial property markets.

The High Cost of Credit
If there’s a single fact that bodes ill for commercial real estate, it’s the virtual disappearance of the commercial mortgage-backed securities market. At its height in 2007, the CMBS market accounted for trillions of dollars in commercial real estate debt. Now, new CMBS loans amount to next to nothing, says Ashley Harkness, senior vice president in the Dallas office of Capmark Financial Group Inc., a commercial real estate financial services firm.

 “The [CMBS] market generated so much business through the third quarter of 2007,” Harkness says. “Now it has gone flat.”

As a result, borrowers have been forced to look to banks for short-term debt and to life-insurance companies for longer notes—two sectors that were particularly hard hit by their exposure to residential real estate. With few other options, Harkness says, clients looking for financing only have the government-sponsored entities left. “There are three types of lenders who are active,” he says. “Fannie, Freddie, and the FHA.”

It’s not that banks aren’t lending, says Dan Easley, senior vice president and manager for commercial real estate lending at BOK Financial Corp., the parent company of Bank of Texas. It’s just that the costs of those loans are more than many property owners can afford.

“Pricing has gone up at least 100 basis points,” Easley says. “Non-recourse loans [those that have the borrower’s personal guarantee] are out of the market.”

Banks also are looking to leverage their lending power and bolster their balance sheets by requiring borrowers to move their business accounts to the bank where they’re borrowing.

“Any banker worth his salt is going to try to establish a holistic relationship and gather deposits,” Easley says. “They are not going to just throw money out the door.”

In addition to higher rates, borrowers are now forced to provide more equity upfront. “Where you used to see loan-to-value ratios in the 70 to 80 percent range,” Harkness says, “now [non-recourse commercial deals] are in the low to mid-60s.”

On the one hand, the dearth of debt to finance real estate projects and purchases may not be a bad thing. If the residential crisis has taught us anything, it’s that no matter the short-term gains, a glut of cheap credit can do great damage to the economy in the long run. So, the thinking goes, the current high cost of debt may help crimp supply and correct market pricing.

But the real fear among real estate experts concerns the fallout from those properties whose debt was funded under the soft conditions of a vibrant securitization market. As those loans begin to come due this year, property owners will have two options: sell at a discount or refinance. And those looking to refinance will have few options.

“The first round [of CMBS loans] were made five to 10 years ago, and those are coming due,” Easley says. “The only source of similar debt are the insurance companies. And there is only so much liquidity out there.”

The former reach of the CMBS market leaves every sector of commercial real estate at risk: retail, multifamily, industrial, even office. Says Easley: “It is a domino effect.”

For property owners without available credit, the options are limited. They could sell, likely at a loss. They could pour additional equity into the property, nullifying the potential return on their investment.

Or, as SMU professor David Lei sees the credit crisis playing out, owners could take the option many of their tenants are taking today. “The second shoe,” Lei says of the credit meltdown, “will be large-scale defaults.”

Simek is a freelance writer in Dallas who also contributes to People Newspapers. His last article for D CEO, in the January issue, was about the late ’80s savings and loan crisis.