Popular water cooler talk about our ailing commercial real estate marketplace may now be “so-2009″. Evidence continues to mount that we have turned the corner on several levels. Most know that job creation must recover to make up for lost time, but market-timing indicators are very favorable for users and investors of commercial real estate. The window for good opportunity is wide open right now.
For the first time in years, we are noting positive absorption of commercial real estate space. This, after the two previous years registered red ink in the same analysis. The delivery of new space has largely stopped, and there was no significant amount of speculative space delivered to the market. Capital providers and developers have turned the building spicket off. Vacancy rates are stabilizing in many parts of the country. Despite a continuing imbalance between landlord offerings and tenant-users, vacancy levels are still not at historic highs in many areas.
So what is the compelling indicator of market opportunity for a user or investor? We still have more sellers than buyers, and a large percentage of space on the market has lingered for over one year. Yet, digging deeper, some interesting analysis can be made.
While our vacancy rates have declined over this last year (as indicated by the positive net absorption), rental rates are still falling. Landlords who have had little activity these last few years are getting anxious to fill their space and tenants moving to new space can negotiate advantageous lease rates. Landlords cannot wait for the market to “catch up” with the good news and stabilize their rental rates. Short term, tenants are still able to take advantage of the landlord’s pain these last three years, even though market conditions could be interpreted to be favorable for landlords now to hold their asking rates.
One out of every ten property owners in our area has listed their buildings for sale, which is twice the rate typical in the mid-2000s. Transaction volume is still low and asking prices per square foot are dropping. Negotiation imbalance can be seen in the selling price to offer price differential, which favors the buyer. . Simply put, buyers are in a superior negotiating position. Consequently, we’ve seen opportunistic buyers start to enter into the market to seek value. For example, our office recently fielded eight offers immediately on a discounted lender owned property offering, priced significantly below replacement cost. When an offering is priced at 50 cents on the dollar or less, the market will respond.
Capitalization rates have risen over the last few years, and now approach 9% on average outside of major metropolitan areas. This means the investor can obtain higher returns than those available in the last decade. With the fresh memory of CRE problems over these last three years in mind, buyers are asking for higher returns in their negotiations. The “core” end of the market has more buyers looking for high yields, but ones that are relatively safe for years to come. The “distress” end of the market has buyers looking for sufficient discount to entice them to take on the market risk. Meanwhile, the middle of the road properties seem to be the ones receiving almost no attention from buyers.
We will have a few more years before legacy financial issues are fully washed out. As more distress properties are released to the market after lenders have moved into ownership, very nice buys are available to users and investors. Those who can participate in this “workout” are taking advantage of this unique “good news, bad news” environment. Just like a physical “work out”, the users and investors diving into the market now will be stronger in the long run.