2022 Commercial Real Estate Predictions

 

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I know, I know. You’re weary of yet another prediction column. By the time you read this, we are well into January, I’ve celebrated another sun orbit, and the Super Bowl has been moved to Texas - now there is a prediction! But I digress. I’m a bit leary to prognosticate as my crystal ball was quite clear last year. But I’ll hop out there and make a few.
 
Industrial rents. They’ll increase. Next bullet point. However, I’ve a few more words, so stay with me. We track Class A inventory for an upcoming assignment. What’s that, you may ask? We describe Class A inventory as buildings constructed since 2000. In this way we are able to weed out functionally obsolete structures that may exist in the market. In Orange County, there are eight new developments proposed or under construction totaling over 2,700,000. A staggering number until you factor in what’s available today. Ummm. That would be one. That’s correct! One available. Demand is still strong so nowhere for rents to go but up.
 
Developer appetite. With industrial rents increasing, interest rates still low - that will change this year - plentiful capital seeking a place to reside, and an acute shortage of land from which to produce concrete caverns - a conundrum continues. An industrial development at your neighborhood Sear’s store? A campus built for industries who’ve left the area? All will be targets this year.
 
The office. No, not the series - the market. Recently, I read this with interest in these pages - “A new report from Ladders, a career site for high-paying jobs, says things will likely stay that way. In fact, Ladders predicts that 25% of all professional jobs that pay $80,000 or more will be remote by the end of 2022.” Wow! My suspicion is it will be greater than that. Anecdotally, take our office as an example. We own a 21,700 square foot, two story location. We occupy the upstairs and a portion of the down for about 13,000 square feet. When locked and loaded - 49-52 folks commuted in each day. Now? Probably half regularly attend. My team works remotely as do others. Adjusting to this change will be smaller footprints and more multi-use spaces.
 
Retail slowdown? We all know that, big fella. How’s that prescient? Actually, what slowed during our two year pandemic fueled sabbatical were trips to the store. Retail sales actually increased as we bought tons of stuff from our home keyboards. But, one of our clients, corporately based in NYC, is a tremendous gauge on the brick and mortar retail business. By that I mean, destinations such as Wal-Mart, Costco, Burlington, and the like. He’s sensed a REAL dip and predicts more to come. So we’ll see.
 
Stagflation. What on Earth is that? According to Wikipedia -“In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.” Hmmm. Inflation rates, high - check. Economic growth slowing - check. Unemployment high - check. By the way, you may be thinking - I thought unemployment was low, currently. Actually, the percent of the workforce NOT working is high. The statistics reported are only those who’ve filed claims - quite misleading.
 
So, there they are - my 2022 predictions. Stay tuned this time next year to see how I did.
 
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.
 

What Investments are BEST?

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As 2022 commences…with four seasons ahead, a NCAA college football champion to be crowned tomorrow - go Georgia - mid-term elections, and a few resolutions still in tact - I thought it would be revealing to discuss the various ways folks invest in commercial real estate.
 
Recently, I had this conversation with a friend and client of mine. He’s certainly not a novice as he’s owned commercial real estate. The subtle difference, however, is he’s owned it to house one of his operating companies. Some would refer to this as an owner-occupant. Sure, the commercial real estate is an investment, but the tenant - in an investor owned business.
 
But on this day, his wife and I reviewed the various genres and my recommendations for their portfolio. I should also mention, their need to deploy money into an income property was triggered by the sale of another income property. Therefore, we will be utilizing a tax deferred exchange - AKA a 1031.
 
Currently, their holding is a special purpose building in town - one the family has owned for decades. Typical in this scenario - the neighbor approached them on their willingness to sell. Usually met with a no, this go around the answer was yes. A contract was drawn and closing is scheduled mid-month.
 
During our lunch meeting - after all the grandkid stories were exhausted - his question was simple. If this were your money, how would you invest it? Here’s what I shared with them.
 
You’ll first need to determine your comfort level with risk. Next, determine how actively you’ll manage your acquisition. Finally, what is your exit?
 
Let’s start with risk. Generally, the riskier a stake in real estate - the higher the return - in our parlance, a capitalization or cap-rate. Consequently, a twenty year industrial lease with Amazon as the occupant should yield less than a Petco store with a 2023 expiring lease. Why? Because the rent Petco pays may be interrupted next year. They may bolt! You’ll then have to originate a new lease with all the appurtenant costs of down-time, brokerage commissions, rent concessions and the like. Some investors may find favor. If the Petco can be bought at a discount, costs of a new lease covered, the rewards can be great. Other, more risk adverse buyers would prefer the lower “guaranteed” return a long-term lease affords.
 
How you’ll collect the rent - or the level of your involvement - is your next consideration. Generally, a retail strip or incubator industrial property will sport multiple tenants with varying lease expirations, credit worthiness, and drama. Sorry. Can’t pay you this month because one of our customers stiffed us. For a percentage of the rent check, a property manager can be employed. You then avoid the calls on Saturday with a leaking toilet. But. The luxury of a middleman depletes your check at the end of the month. Single tenant assets, like our Amazon example, have virtually no management. In fact, if the lease is Triple Net in nature, you simply collect each month - no management necessary.
 
Finally, let’s consider your exit. You see, pouring money into commercial real estate is not like buying a stock, bonds, precious metals, or art. Sure. Risks abound with any gamble. The difference is the liquidity. If you buy a share of General Motors and decide to sell it - buyers are plentiful and stock markets prevail. Commercial real estate is a bit trickier. Imagine selling in 2009. Yikes! Therefore, how you’ll depart the investment must be weighed. Some like to buy, put the token on the shelf, and allow their grandkids to decide what to do years from now. Others prefer to create value and bail. Certain types of buildings lend themselves to value addition. Take office buildings as an example. With our pandemic fueled uncertainty with office suites, some may be drawn to the higher returns an investment in office may allow. Fill it with good paying long term tenants and sell it. Love it or list it, indeed.
 
Our guy prefers a lower risk, little management and plans to hold long-term. Therefore, at the end of our discussion - we decided to focus our search on a single tenant industrial building with a mid-length lease of 3-5 years. Our expectation is a return in the 4% range.
 
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.
 

How’d I do in 2020?

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Happy new year! If you’re reading this - 2021 is now a footnote, the Amazon boxes are broken down awaiting delayed pickup, and many of your resolutions have already been broken. Wow, that didn’t take long! I took a look back at my predictions for calendar 2021. The column was authored post T-giving and pre-holiday 2020. Some 13 months ago. How’d I do? Spoiler alert. I was a freakin Nostradamus!
 
From late 2020: 
 
Wow! December. With Christmas lights festooning the neighborhood - we are reminded 2020 is almost history! 2021 is a mere 30 days hence. What can we expect of the commercial real estate landscape next year? Someone famous once opined - “well, they’re only predictions, but they’re all mine.” So please bear with me as I get my Nostradamus on.
 
Bullish industrial owners. We represent an importer. Warehoused are goods they distribute. He’s slammed for space - thus our engagement to find more. Recently our full priced offer was met with a reluctance - by the owner - to grant a financing contingency. I’ve seen this with investment properties - but never with owner occupied real estate. You see, time is needed for a lender to nod yay or nay. Very few occupants have idle cash sitting in an account awaiting a purchase. Today. Nailed it! Same occupant is still in the market. Prices have hopped 50% in 2021!
 
Shorter leases. Until the aroma of economic uncertainly ceases to waft, expect occupants to seek commitments of fewer years than before. Ten year leases will become five and so on. Today. This is certainly the case for office suite deals. Expect more of this in 2022.
 
Clarity in the office market. I suspect by this time next year - the runway will be clear and office occupants will have a direction - up or down. As previously mentioned, uncertainty is a killer for any business trying to gauge a need for space. But, as we are seeing in retail storefronts with their downward trajectory - at least we can plan. Today. Yeah. Not so much. The office landscape has seen fits and starts. Mid-year - when our state fully reopened - was derailed by Delta. And now with Omicron sweeping the caseload, it’s anyone’s guess when business will fully return to the office.
 
Low interest rates. The Biden administration will most likely be gridlocked by a Republican senate. With the house near balanced, a Democrat in the White House and a red senate - expect the Federal Reserve to keep interest rates low. Our ten year treasuries - a bellwether for commercial real estate loans - are expected to wallow at historic bottoms as well. Today. Spot on! Although, those storm clouds massing? Yessir. Those are higher rates coming.
 
Burgeoning ECommerce. If the Buchanan household is any indication - internet ordering and “just in time shipments” to your door will continue with a vengeance. Recently, we purchased a new mattress on-line. The next day, two beefy gentlemen ushered it into our upstairs master suite. Will someone kindly develop a box compactor for home use? Something between the kitchen trash masher and the ones in Albertson’s storeroom would be awesome. There’s your million dollar business idea for 2021! You’re welcome. Today. Boom!
 
Continued safety protocols. As the pandemic blossomed in March, predicted were temperature checkpoints, masks, hand washing stations, and distancing. Actually, it was not terribly futuristic. Observed was what other countries were employing. I am startled how quickly we adapted, however. Akin to airline changes post 9.11 - we can’t simply attend a concert, eat in a restaurant, or shop without a face covering. Shocking. Although, expect more in 2021. Today. A new mask mandate, proof of vaxxing, 2020 redeaux? Maybe.
 
An innovative technological offering? Commercial real estate is rarely disrupted by something shiny and new. CoStar - in the mid 1990’s was probably the last big thing. With CoStar’s acquisition of Ten-X this year - we could see a more robust platform from which to transact. At the site’s disposal now is available inventory, what’s recently sold, and an auction template. Hmmm. Where do brokers fit in? But, look no further than our residential counterparts to get a glimpse. Matterport tours, consumer facing available inventory, and accurate internet loan processing lessen the need for “buy-side” representatives. Today. Well. Missed this one. Unless of course it’ll appear in 2022. Tic Tock?
 
Scant industrial vacancy. I see nothing on our immediate horizon that would cause industrial availability to rise. The drivers of increased square footage could be new construction. Nope. Not enough vacant land in the OC to stem demand. Plus, it takes an eternity to get a new development entitled. Business failures - probably not. We’ve just endured the greatest health crises in 100 years and many industries thrived. Exodus out of state. Maybe. We’ve definitely seen some movement. However, our local businesses are largely private. They’re your neighbors with a rich history and deep rooted residency in SoCal. A financial meltdown. Yeah. That could do it. 2009 again. I certainly hope not. Today. Again, nailed it! Frankly, it’ll take something catastrophic to get us back to a normal vacancy of 5%. Between you and me - I’d prefer the scant vacancy! 
 
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.
 

Lunch with Rob Neal - Hager Pacific Properties

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With a holiday lull fast approaching - no I’m not predicting a long-term downturn in commercial real estate activity; just the normal respite that occurs at the end of every year - occasioned was the opportunity to lunch with a dear friend, Rob Neal of Hager Pacific properties. Rob and I have known one another since we had different colored hair, but I digress. Our time was a chance to measure our collective gauge on the commercial real market and enjoy a bit of Christmas cheer.
 
For all three of you who don’t know Rob, “he is a managing partner with Hager Pacific Properties and oversees the firm’s acquisitions, renovations and dispositions. He is also an active community member and holds or has held board positions with the following non-profit organizations: the Orange County Council of the Boys Scouts of America; Catholic Relief Services; The Becket Fund; Catholic Leadership Institute; The Pacific Club; Magis Institute of Reason and Faith; the Orange Coast Chapter of Legatus International; Second Harvest Food Bank, and Christ Catholic Cathedral Corporation.”
 
A bit about Rob’s firm, Hager Pacific Properties. “Using internal capital, they specialize in purchasing properties that range from those in stabilized condition suitable for a long term hold to those that are aging, vacant, environmentally impacted, or under-performing.” Over the years, Hager has amassed a portfolio of close to 120 properties and 14,000,000 square feet. They’re one of the largest private property owners in the United States.
 
Serenaded by Christmas carolers as I arrived at our meeting spot - my mind recalled another lunch with Rob on March 9, 2020. The pandemic was becoming a thing and Rob was particularly melancholy that day. His normally upbeat outlook on the future was quite dark. Because Rob was concerned, I became nervous. Four days later our state was locked down. Wow! He was quite prescient.
 
21 months hence, 37.2% in rent increases, industrial demand off the charts, constricted supply chain, and one new grandchild each - could he have possibly predicted the favor manufacturing and logistics buildings have enjoyed? A resounding no, according to Rob. His why - I found illustrative. Certainly people are buying more on line. Ok. Got it. But Rob described it like this. We have - and are continuing - to rebuild our supply chain. Here’s how. Not so long ago, we visited VERY expensive warehouse spaces filled with stuff. In these buildings - the ceilings weren’t particularly tall, the loading was a bit compromised, but they were well located on busy intersections. We as shoppers bought, loaded, and transported the purchases to our homes. Predominant on the building’s front, on all paper bags and carts were names such as Von’s, Ralphs, and Albertsons. Yes! Your local grocer. Rob noted the biggest change he observed during the pandemic were folks our age…50…err…ish joined the Amazon party - our generation started ordering food on-line. Initially, because we hadn’t a choice. But once we got a familiarity with the simplicity and ease - we became believers. Hmmm. What else can we order and have on our doorstep tomorrow? Everything but the kitchen sink. As a matter of fact - the kitchen sink also - Kohler, Kraus - you name it.
 
So why the meteoric rise in lease rates? Rob believes - as do I - it’s purely supply and demand. We’ve endured limited availability of space, acute lack of new development - supply, coupled with rebuilding our supply chain - demand. Larger, taller, and more centralized are the e-commerce distribution centers with the flagship Amazon adding 300 new warehouses in 2021. A voracious appetite with no Christmas leftovers.
 
When does it end? Rob and I read with interest the Chapman Economic forecast published last week. An anticipated rise in borrowing costs will cool the sizzling home buying binge and result in price depreciation of 3% in 2022. Expect, according to Chapman, a recession in 2023. The culprit? Rising interest rates. Rob’s take was a bit more granular. Mentioned was the 50,000,000 square feet of new industrial development in Dallas. After all, how will they house the exodus from California? Building is easier outside California and Rob believes this “over-built” episode will cause price concessions. Something none of us foresees could derail us. Like a 100 year pandemic? Ok. Bad example but you get the idea.
 
Belated Merry Christmas to you all. I hope you enjoyed the lunch chat as much as I did.
 
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.