Pace of commercial recovery cools

08/19/2015

stan stouder, News-Press

The California wildfires fueled by plenty of dry tender created from years of drought are similar to the recent resurgence in the commercial real estate market in Southwest Florida, which after years of drought caught fire again. Unlike the California fires which seem to continue to blaze, as of this quarter, it appears this commercial real estate resurgence, while still burning, has begun to flicker.

Why might the heat of our commercial recovery seem to be cooling? It is cooling in part due to little speculative development despite rents rising, since they’re rising at a slower pace than the rapid pace of increase in the cost of new construction and less than forecast absorption of new homes, especially over $250,000. We’re delighted that in the existing building stock across the board vacancies are dropping and rents are rising. But except for niche markets, e.g.: Collier County industrial or multi-housing, in general the pace of rents increasing still lags behind the pace of new construction costs rising sufficient to warrant broad speculative development in all sectors and markets despite low interest rates and the partial reprieve from impact fees. Until construction costs and rents come into balance, and they slowly are, speculative construction to help fuel this recovery seems unlikely.

What demand has been driving this resurgence? It has been primarily from users of space. Users are making rational business decisions based upon potential revenue and costs here. This is a good thing because it is rebuilding us on sustainable footing.

Much to our glee many of these users were national companies with strong balance sheets in need of larger space in short time periods. These users were largely cash buyers, or well-funded tenants making them undeterred by today’s funding rigors largely due to Dodd Frank regulations that make securing commercial real estate financing so cumbersome and intrusive. We are not as gleeful about the stubbornly high positive correlation between occupancies to the return of residential construction.

In many cases these users are buying or leasing existing properties from investors who took the risk to buy them at steep discounts from distressed owners during the real estate drought. The owners who bought these properties at aberrantly low prices are now enjoying substantial paydays and are charging lower rents than users alternatively will have to pay to occupy new construction. This user-driven market has buoyed values out of the ashes and back to reasonable levels, but there isn’t an infinite supply of users or buildings available from investors with an artificially low costs basis.

For those buyers that bought at the bottom of the market returns have been tasty. In Southwest Florida, as it relates to retrading of commercial properties, we have done an analysis of properties which sold more than one time over a 54-month period between 2010-2015. This is what we call the Repeat Sale Index. In an effort to normalize the data the islands — Sanibel, Captiva, Fort Myers Beach and Pine Island areas — are not included in the analysis. As the attached chart reveals the average annual return ranges from a low of 5.76 percent for office condos to a high of more than 39 percent for general retail with a median of 23 percent. Commercial real estate continues to produce returns well in excess of many competing investments. These are stellar returns and once more validate the axiom that in real estate you make money when you buy.

Appraisers are doing a fine job reconciling the present step-ups in values from user buyers to the values from the beleaguered past. Interest rates still remain tantalizingly affordable for anyone who is prepared to personally occupy 51 percent or more of the property and run the gauntlet of underwriting that Dodd-Frank or SBA financing now requires.

There is a groundswell of people less confident the pace of the commercial real estate recovery in Southwest Florida will sustain its current arc with looming interest rate increases, plateauing residential absorption, increasing government intervention and global uncertainty. The consensus is things aren’t going to crater again but they may not continue to get better as fast. If our nascent recovery resembled California wildfires our current state of recovery is beginning to look more like the plains of Kansas, even before our recovery has fully recovered.

For more details and analysis check out our latest Market View report available free at creconsultants.com.

Stan Stouder, CCIM, is a founding partner of CRE Consultants. He can be contacted at stan.stouder@creconsultants.com.

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