Are you really prepared to navigate the peaks and valleys of commercial real estate? Current and anticipated changes will likely require adjustments in how both tenants and owners approach the market.
“It depends on the specific geography you’re operating in or the product type that you intend to occupy whether it’s retail, office or industrial,” says John Behm, managing principal at CresaPartners. “But, in general, the statistics are indicating that the markets are peaking.”
Smart Business asked Behm for more insight into what to expect over the next several quarters.
Has the commercial real estate market peaked?
We believe that the market has actually peaked. However, it is not a sharp peak followed by an immediate decline. Rather, we are looking at the future as being a plateau, and it may stay flat for a few years. There are certain markets and specific properties within these markets that experienced a rapid increase in rents, and these have now become difficult to substantiate. A correction here is inevitable, and we see that happening over the next 12 months.
What does this mean for tenants?
That there is opportunity as well as consequences for getting it wrong. Tenants should see rents that don’t reflect the same rapid annual increase that they’ve been experiencing, if they know where to look. It’s not likely that all tenants are going to see a substantial decline in rates, but certain decreases will be significant if you can identify the opportunity. However, there’s a catch. The current reduction in rental rates is good news, but overall economic stagnation is not. The goal is to develop a clear plan to align the company’s forecasted needs with the market conditions, and this requires some careful coordination involving both the business and real estate professionals.
Can tenants prepare for the shift?
Yes. Every tenant can have an effective response to market adjustments. It sounds unusual, but a good real estate transaction is one that includes an exit strategy. This can be the ability to terminate the current obligation, a right to contract or expand, a right to renew, or a right to sublease or assign, as examples.
In addition, regardless of whether the market is peaking or declining, companies with a good understanding of their business needs will make real estate decisions on sound metrics, such as real estate costs as a percent of revenue, revenue generated per square foot, cost per employee, etc.
Planning into the right commitment will result in the real estate supporting the company’s operations and not creating a situation where the business is needing to support the real estate.
What about businesses that own buildings?
These changes are primarily going to affect their ability to obtain capital that will be required for the ordinary operations of those buildings for the fit out of new tenancies, needed capital improvements or unanticipated maintenance items.
What affects these market changes?
There are a number of factors that affect the commercial real estate market. Employment growth, as one example, has been declining since 2006. The number of office jobs has also been declining in the region and nationally since 2006. As of late, the subprime issue with its subsequent credit crunch is really beginning to show itself in the marketplace as companies large and small become increasingly cautious with decisions involving any long-term financial commitments.
What can owners and tenants do to keep up with the changing market?
Scenario planning is important. This is a simple answer that is often hard to execute. Leases are most often longer-term commitments (three to 10 years) and, while forecasting operational needs can be difficult, it is helpful to model a few different scenarios that overlay business needs with the realities of the real estate market. This discipline can help you actually get out in front of markets and provide an opportunity for savings or cost avoidance.
JOHN BEHM is a managing principal with CresaPartners in Philadelphia. Reach him at firstname.lastname@example.org or (610) 825-3939.