Diversify and innovate to succeed in a jumbled environment
The current real estate market is difficult to summarize because, as Alan Kaplan, a Grant Thornton Director of Advisory Services, puts it: “There are simply too many pointers pointing in too many directions.”
For while it is influenced by macroeconomic trends, the market shows surprising variations between geographies, sectors and asset classes. Market conditions can vary within a metro, with suburbs thriving while the central business district struggles.
“Most investors are currently in a wait-and-see mindset. However, well capitalized investors are in a strong position for opportunistic buying.”
Headwinds and headcounts
That said, the larger forces affecting real estate are very real, according to Don Davidson, a Grant Thornton Managing Director of Advisory Services. After a healthy 10-year run, transaction volume is down significantly. Banks, especially regional banks, are under intense pressure to tighten up lending standards. While inflation has fallen since its peak, it still exceeds historical norms, and interest rates have continued to rise.
As many in the workforce are working from home, entire floors of some offices have emptied. Some of those people will stay away for good; others are coming back. This can often vary by market and over time, depending on the policy shifts of large employers. Most market participants expect some level of recession in 2023, which will add further confusion to the real estate markets.
While high-quality space in good metros is still seeing strong rents and occupancy rates, many second- and third-level properties in central business districts are struggling. Kaplan observed, “Some buildings are no longer supportable in their current state. The highest and best use may be to demolish them.”
On the other hand, the surge in shipping means that the warehouse sector is generally thriving, as regional, local, and hyper-local distribution centers add capacity. With the rise of onshoring, manufacturing real estate seems healthy.
Be cautious but nimble
The current market promises to reward prudence, diversification, opportunistic buying, and innovation. According to Davidson, “Most investors are currently in a wait-and-see mindset. However, well capitalized investors are in a strong position for opportunistic buying.”
Given the differences between markets and sectors, it’s more important than ever to seek meaningful diversification. “Meaningful” is the key word here. Kaplan noted, “It’s possible to be diversified on the surface, with holdings in different geographies and market types. But if you look deeper and realize 70% of those holdings are with the same tenant, you’re still at risk.”
There are opportunities to be seized. Many smaller markets weren’t overbuilt — and some are becoming more attractive as office workers flee the larger metros. Similarly, a compromise between returning to central business district office towers and working from home may boost offices in the suburban ring.
Tip: Turn office space into affordable housing?
Two trends currently exist side-by-side: the need to fill empty office properties and the need for affordable housing. Grant Thornton Managing Director, Advisory Services, Don Davidson emphasized: “We've got a huge supply of old office space and a high demand for something that falls under the radar of most commercial real estate: affordable housing.
“Of course, conversions such as this would be very challenging and would require some very innovative thinking. It would likely require a public-private partnership so that the housing is affordable and the properties stay viable.”
Of course, a dose of innovative thinking may help salvage underperforming properties. For example, tenants who need less office space may also be open to amenities such as gyms or day care facilities, which could lure employees from their homes. In addition, departing long-term tenants may be replaced by tenants with shorter-term leases who are willing to pay a premium for greater flexibility. After all, before the pandemic, the coworking movement capitalized on the desire of workers to have a space outside their homes. The need for a second space, which powered that trend, still exists.
The pandemic provided another example of innovative problem solving. As tenants struggled during the pandemic and landlords had to offer concessions — three months free rent for example — landlords might have asked to extend the lease for three months at the end of the term or provide for the tenant to pay the rent concession back over the remaining life of the lease. By changing terms slightly, it provided relief for the tenants and made concessions acceptable to landlords. Similarly, creative arrangements may be called for in today’s distinctive market.
All of this is complicated by the long-term nature of commercial leases. It’s certainly tempting to hold parties to onerous contracts, but it may not be wise. If unprecedented market forces make the terms of 20- and 30-year leases unlivable, it may be prudent to suggest ways in which both parties can win. Otherwise, you risk costly defaults and even unscrupulous evasions.
Plan to be surprised
The key to prospering in such a market will be solutions that go beyond the obvious and analysis that goes beyond the superficial. Of course, that’s always been the case.
Our real estate and construction featured industry insights
No Results Found. Please search again using different keywords and/or filters.