An Investor Briefing

I consume a ton of economic news each day, week, and month. Maybe it’s my degree. After all, I do have a Bachelor of Arts in economics. It could be I’m smitten with numbers. Or possibly, I believe having knowledge of the broader economy - not just what’s happening locally makes me a better resource to my clients and prospects.
 
Recently, I delivered a briefing to my investors which I believed was column worthy.
 
Macro economy. If you watch CNBC, attend conferences, read this publication or the Wall Street Journal - you know the Federal Reserve is on a tear to tame inflation. Their only hammer to tamp down the nail is to systematically raise the rates banks pay to borrow. For years this rate was next to nothing but now hovers around 3.5%. Plans are for this rate to eclipse 5% by year’s end. The hope is that by doing this the supply of money will be choked - causing it to be more expensive. How does this trickle down to the pump and the grocery checkout line? With less money circulating, the theory is competition for purchasing will also lessen thereby causing downward pressure on pricing. In short, this takes time. Consumer interest rates have also risen. A mere year ago, you could originate a thirty year mortgage of around 3%. Now it’s over 7%. Still historically cheap money but not compared to last year. And finally, we have an economy poised for recession - some believe we’re already there.
 
Commercial real estate asset classes. Folks continue to buy and consumer confidence is bustling. Certainly the way in which dollars are expended was forever changed by the pandemic. Savvy retailers who provide an experience are thriving. Those who simply sell things are struggling. Thus the state of retail.
 
If our economy should truly recess in 2023 - a return to the office might be the unintended consequence. Getting more from fewer and having them close could stem from a downturn. Expect headcount to reduce in 2023. Look at big tech such as Twitter, Meta, Alphabet, and Apple - preemptively planning for a reduction by mass layoffs.
 
The drivers of the huge uptick in industrial demand are cooling. Because we’re back to work and not strumming our keyboards means less on hand inventory is needed. The big retailers have commenced the purge. Third party logistics providers - especially that cater to folks who sell things - need less space.
 
All asset classes are experiencing a rise in capitalization rates - the percentage that defines your return on an all cash basis. The question is - what’s causing the bump? Some opine as the cost of borrowing increases - cap rates must climb lest there be negative leverage. You’ll find a school of thought believing it’s all about fear and greed. As interest rates rise, uncertainty is created which causes some investors to tap out - fear. With the buyer universe smaller - less competition - pricing must be reduced to generate activity - greed. I believe it’s a combination of both. We’ll see less equity selling in 2023.
 
Commercial real estate micro trends. Manufacturing and logistics buildings are still in extremely short supply. 99 of every hundred buildings is occupied. Rents for class-A industrial are now over $2.00 per square foot. For context - those rents were only $1.00 in 2021. In Orange County, many exhausted manufacturing campuses have been retired. Once bustling operations such as Kimberly Clark, Beckman, Schneider Foods, Kraft Heinz, Boeing, and National Oilwell Varco have been replaced with monster boxes to fill the pressing need for the new purchasing paradigm. Repurposing aging research and development campuses has found favor with many developers. Examples include Ricoh, Bank of America, OC Register, and locations along Imperial Highway in Brea.
 
What are tenants thinking. Companies that occupy buildings and pay rent are bracing for impact. As mentioned before, class-A industrial rents hovered around $1.00 per square foot only a year ago. They’ve since doubled. Operations whose lease payments comprise a small percentage of their overall cost structure are taking the increases in stride. But, closely held businesses are realizing increased rent will reduce their margins and may not allow for hiring, equipment purchasing, or acquiring a competitor.
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.