What to expect for the balance of the year with commercial real estate.

As I write this column there are approximately nine months remaining in 2023. Yes. The year is slipping by quickly. And now with the tax deadline postponed until October - the landmark signaling “it’s time to get rolling” each year has vanished. The first three months of 2023 have been curious. Overall, the amount of industrial activity has waned. Certainly compared to Q1 of 22 but also compared with the last half of the year as interest rate hikes, inflationary pressures, and global turmoil created uncertainty. So what am I watching and what should we expect for the last gestation period of 2023? 
 
The Federal Reserve. Our central bank is in a real quandary. On the one hand, inflation has proved stubborn - due primarily to consumer spending, the cost of shelter, and services. On the other hand, if the Fed resumes its aggressive rate march up the ladder, it risks causing other bank failures. As well, a pause could be an indication they’re concerned about breaking something else which could further shake confidence. Two weeks ago, I was in the camp expecting a 50 basis point bump. Now, I believe we’ll see a 25 basis points. This will increase the Fed Funds Rate 4.83%. In January of last year it was .58%. Will we reach a 6% target as anticipated this year? Unlikely at the point. But with the fluidity with which we saw events unfold over the past week - it wouldn’t shock me.
 
Class A industrial leasing activity. Our market is delivering more class A industrial inventory than ever since we began tracking such things in 1990. Fueled by a low cost of money, large global manufacturers making a decision to sell their aging campuses, and rabid developer appetites with an institutional credit card and desire for returns - we saw such name brands as Kimberly Clark, Boeing, Beckman, Kraft Heinz, National Oilwell Varco, Schneider Foods, Ricoh, and others hit the exit ramp. Resulting has been an array of beautiful new logistics spaces with all the new amenities of upgraded warehouse fire suppression, super high stacking capabilities, and marvelous truck maneuvering. Just over 2,700,000 square feet of new addresses are open for business and seeking residents. Goodman’s development in Fullerton - on the old Kimberly Clark site and been noteworthy. Delivering first in an otherwise crowded waiting room and with size ranges not normally found in North Orange County - 100% of the 1,600,000 square feet have been leased with recognized names such as Sprouts, Samsung, and Bandai. Very successful! What remains to be born are a number of buildings of essentially the same size range - 120,000-200,000 square feet. I believe we’ll see some lease rate softening in order to get all the buildings absorbed.
 
Office building defaults. A perfect storm is brewing. First, our hybrid working environment has cratered high rise occupancy. Second, office deals are expensive to originate. Once downtime, rent concessions, beneficial occupancy, tenant improvements, and broker commission bonuses are computed - roughly half the income an owner will receive is pre-spent. Next, our stock of office buildings in Orange County is aging and many don’t provide the modern experience many office tenants are seeking. In order to retrofit these vintage spaces is extremely expensive. Plus, the investment doesn’t guarantee a higher level of occupancy or higher rent. Finally, we’re in an unfavorable interest rate environment that is filled with lenders unwilling to loan on office space. My sense is some owners will opt to hand over the keys to the lender vs investing a ton of money to bolster leasing activity.
 
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.