When will we see a downturn? – Orange County Registry
When meeting with clients and prospects these days, most are curious about my opinion. Specifically, when will this frenetic market activity begin to subside? Frankly, I am shocked by the exponential rise in rental rates and purchase prices that we have experienced over the past year. Talk to any commercial real estate professional and most will admit they didn’t see it coming.
When our economy went on collective hiatus two years ago, uncertainty abounded. Most of us believed that the pandemic was the black swan event that would derail the status quo. Yes, certain segments of commercial real estate have taken off, including office suites and brick-and-mortar retail. But buildings focused on manufacturing or logistics continue to find favor. I warn that my crystal ball is somewhat cloudy, but share with them the things I look at as predictors.
Residential. A decline in home sales typically results in a 12 to 18 month stall in business activity. Before the Great Recession, there were myriad warning signs of an impending downturn. Admittedly, few of us were prepared for the severity of the dive. I remember that one of my construction clients was alarmed by the dizzying drop in housing starts. His group has provided bathtubs for new housing projects. Businesses like these are an indicator of attractions to come.
New construction. Currently, industrial demand greatly exceeds supply. We can’t build enough new sites to keep up with the appetite. Building stocks are gobbled up faster than a teenager consumes an In-N-Out burger. As a result, our stock – new and used – is significantly more expensive. I am currently watching the next set of leases and sales to assess whether the market will continue to rise or stagnate. Similar to the lightning that precedes a thunderclap, we wait for the next strike to determine how close the requested rates are.
Interest rate. The cost of money affects so much. I could spend an entire column on the subject. Suffice it to say, we’ve enjoyed a decade of low interest rates for life. These cheap dollars fueled an unprecedented buying frenzy. Galloping inflation is showing up and forcing policy makers to react. As of this writing, the benchmark 10-year Treasuries are at 2.4%. Still puny if you’re a saver, but at some point returns on investment will be impacted. Capital will flow into a government-backed issue versus a real estate investment if capitalization rates are comparable.
Global Events. Russia’s invasion of Ukraine has put a damper on the global supply chain for energy and food products. Fortunately, even with our sanctions on Russian oil and natural gas, the United States is doing well. But many European countries, such as Germany, rely heavily on imported oil. When it comes to food, Ukraine and Russia are two of the biggest wheat producers and exporters in the world. Planting season is now. We only have a 90 day global food supply. And wheat is in everything! You can begin to understand how this disruption can impact all of us.
Industrial Metrics. We always look at what is available, rented and sold on a daily, weekly and monthly basis. How many places out of 100 are currently on the market? In a normal market – which we haven’t seen since 2013 – five to six out of 100 are available. We are now at less than 1%. In some size ranges, there is none. Something catastrophic enough would have to happen to make the shadow normal.
Anecdotes. On the seller and landlord side, you hear people squeezing rents, hitting monster sale values, and getting unsolicited offers in the wazoo. Occupants complain of raw material shortages, rising costs, fuel surcharges, lack of quality employees and rising facility costs.
So these are my “tea leaves”. I would like to know what you are looking at in order to predict what is to come.
Allen C. Buchanan, SIOR, is a principal at 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.
