Friday, July 21, 2017

A Shortage of Commercial Real Estate - But Why?

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Supply and demand. A basic economic principle first discussed in the seventeenth century by scholars such as John Locke, Sir James Steuart and Adam Smith.

This Adam Smithian see-saw has broad implications in the commercial real estate market. If supply exceeds demand, a buyer's market ensues. Conversely, sellers win when demand exceeds supply.

Currently, Southern California is engulfed in a seller's market largely because of this imbalance between available buildings - supply, and businesses looking to expand - demand.

Seldom discussed, however, are the reasons such an imbalance exists. The reasons, dear readers, are the subject of today's post.

Lack of new construction. An spate of new construction would in fact cause the supply of available inventory to increase - resulting in a parity of demand and supply. But akin to fighting a wildfire with a water pistol, the thirst for supply will not be completely quenched with new construction. So with this shortage of supply, why haven't we seen more building? The reasons are simple. Southern California has a lack of undeveloped land. Virtually all of the new construction we've seen in recent years has started with a site containing obsolete buildings that were razed to accommodate the new construction. New construction is expensive. Land prices are a huge component of new construction - in some cases measuring half the cost - especially since the land includes old buildings that need demolition. The entitlement process is challenging. Cities and counties locally have extensive regulatory requirements in place which add months to the construction time of a new development.

A re-purposing to housing. Many, many thousands of industrial square feet have been retired in favor of high rise apartments and condominiums. Doubt what I say? Just take a look at the area surrounding Anaheim Stadium or John Wayne Airport. Formerly, those areas were home to local manufacturing and logistics businesses. Now gracing the skyline are three and four story buildings under construction that will provide much needed housing to stem another shortage - but at the expense of buildings where people worked and products are made and shipped.

Money is cheap. Companies can invest 10% of the purchase price of a building, finance the balance with a loan through the Small Business Administration, and with Eisenhower era interest rates, enjoy a payment that closely approximates a lease payment - but while owning. A multitude of companies have taken advantage of this structure and the abundance of capital.

When will our markets return to normal - if you can define normal? Unfortunately, my crystal ball is as murky as the SoCal sky on a June morning.