The Market Disconnect

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As I’ve written, in this space, numerous times - uncertainty is a killer of markets. Please allow me to elaborate. When investors or business owners have a murky view of the future - reluctance to make commitments abounds. Conversely, an optimistic opinion of what’s coming leads to hiring, equipment purchases and operational expansion. Therefore, we see long term leases and commercial real estate purchases transacted. Uncertainty is rampant in office space. Covid lockdowns, which forced many of us to work from home - was followed by tepid reopenings, high gasoline prices and a reluctance to commute resulting in a hybrid workforce. When will all of this stabilize? It’s anyone’s guess. Great deals abound for those office space occupants willing to sign a lease term of five years or greater. In my opinion, office landlords are resigned to meeting the demands of tenants by offering free rent, abundant tenant improvements, moving allowances, and bonus fees for agents.
 
We see a different dynamic unfolding in the industrial sector. When interest rates spiked in mid June, we experienced a tectonic shift in buyer attitudes - especially institutional investors. Many are on the bench awaiting an indication of which way we’re headed. We saw a similar pause in March of 2020. But, six weeks later a boom of epic proportions transpired. This rabid appetite continued through the first half of this year. Record lease and sales prices resulted. But now, we’re witnessing deal retrades - a fancy way of describing requests for price reductions - and cancellations. Even acquisitions which appear to be accretive to investor portfolios are cratering.
 
However, on the flip side - occupants of industrial real estate are thriving. One of our aerospace clients has a nine figure backlog. Another one - who slaps adhesives on tape will record his best year yet. A moving and storage operation we counsel has experienced back to back to back revenue spikes. Three peat indeed! And finally, a group we advise who provides engineering for large commercial air conditioning projects cannot keep pace with the demand. When these business boons require additional space - occupants are met with one in every hundred buildings available. Yes. Correct. A 1% vacancy! Because there’s no place to move, renewal rates have increased. Companies are being forced to get creative in solving their need for space. Some have narrowed their stacking aisles and gone vertical. Oh, but wait. That he swing reach forklift that allows you to pick orders way up high cannot be delivered for 26 months. That’s right! Over two years from now. How’s a business to plan?
 
So what’s up? Why the massive disconnect between investors and occupants? Here’s what I believe is happening. Commercial real estate prices shot up so high with expectations of rent growth and lack of supply. Then we felt some global pressure with Russia’s invasion of Ukraine, followed by four decade high inflation which caused a rise in rates to tamp down price hikes and two quarters of declining GDP. Institutional investors, en masse, chose to be bearish lest they find themselves chairless when the music stopped. Meanwhile, business marches on. Folks are working, wages have risen, demand remains strong, and the stock market is appreciating. It’s as though enterprises didn’t get the memo. Aren’t we in a recession? Isn’t the cost of borrowing more? Yes and yes. But somehow this recession is different compared to others I’ve survived. Generally, we spend our way out of downturns. But this time, the lower echelon of earners is getting crushed by higher prices at the pump and grocery store. No disposable income remains. So it’s a recession of the consumer vs a structural issue with our economy.
 
Only time will tell if I’m right.
 
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.