Pricing - Steps To Anticipate
Recently, we discussed price
reductions and the factors which cause them. In short, when supply exceeds
demand, a shortage occurs - also called an imbalance. This imbalance is like a
seesaw - it’s hedged toward either side with one side up and the other down. In
our industrial market, the number of occupants needed to fill our vacancies is
surpassed by the addresses available. Ok. One of the ways to absorb the excess
is through price reductions. Today, I’ll take an in depth look at the steps you
can anticipate when lease rates soften as outlined by the stages of an economic
cycle.
The Economic Cycle Stages:
1. Vacancies Narrow: Initially,
as the market tightens, available spaces get leased quickly. Businesses expand,
new companies move in, and the surplus of vacant buildings decreases.
2. Rents Grow: As
vacancies narrow, landlords gain pricing power. Increased demand leads to
higher rents. Businesses are willing to pay more due to the scarcity of
available spaces.
3. Developers Build: Seeing
rising rents and low vacancies, developers enter the market. New projects are
initiated to capitalize on the high demand and favorable leasing conditions.
4. Leasing Activity is
Robust: With new developments and a
thriving economy, leasing activity peaks. Companies scramble to secure space,
often agreeing to higher rates and fewer concessions.
5. Developers Over-Build: Eventually,
enthusiasm leads to overbuilding. Developers, eager to take advantage of the
booming market, construct more spaces than the market can absorb.
6. Vacancies Increase: As
the new spaces come online, the market shifts. The supply of available
buildings starts to outpace demand, leading to increased vacancies.
7. Time on Market Expands: With
more options available, properties take longer to lease. The average time a
building sits on the market extends as businesses take their time to choose the
best deal.
8. Concessions Appear: To
attract tenants, landlords begin offering concessions—such as free rent
periods, tenant improvement allowances, and other incentives. These concessions
aim to make properties more appealing in a competitive market. By
the way, this is where we are.
9. Prices Soften: As
vacancies continue to rise and concessions become standard, lease rates start
to soften. Landlords adjust their pricing expectations to align with the new
market reality.
10. Demand Returns: Over
time, the lower prices and favorable leasing terms attract new tenants.
Businesses take advantage of the softened market to expand or relocate.
11. Vacancies are
Absorbed: As demand picks up, the
surplus of vacant buildings gradually diminishes. The market starts to balance
out, with supply and demand reaching equilibrium.
12. Rents Start to Grow: With
vacancies absorbed and demand steady, rents begin to rise again. The cycle
comes full circle as the market moves back toward a landlord's market, setting
the stage for the next economic cycle.
Conclusion:
Understanding these stages helps
businesses and investors gauge the ever-changing industrial real estate market.
By recognizing where we are in the cycle, you can make informed
decisions—whether it’s the right time to negotiate a lease, start a new development,
or make strategic investments. In today’s market, with lease rates softening,
it’s essential to stay informed and adaptable. The key to success lies in
anticipating the next phase of the cycle and positioning yourself to take full
advantage of the opportunities it presents.
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.
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