By Ken Ashley
LOS ANGELES (October 6, 2010)
We know the vacancy rate is sky-high, and we read all the same gloomy outlooks on commercial real estate that you do. Is it insanity to even think about building again? Well, after a visit with our psych, and a big swig of Red Bull, we’d like to
suggest five reasons that it is time to begin the process of putting on hard hats.
Reason 1: It Takes a Long Time To Build These Buildings
A major urban office building can take three years to deliver from first concept to actual product delivery. Even “shoebox” type suburban buildings can take 18 months. Given the financing environment, and bored city zoning and building officials, the first projects will likely take much longer than they used to. If we assume our friends in the development community can pull it off, then suburban buildings would be available for tenancy in mid to late 2012 with urban product following in 2013. If we could see three years into the future, many in commercial real estate would be much richer and would have made different choices in 2007 and 2008. So, developers will begin trying to “make the doughnuts” soon because of the timeline involved…and besides, hope springs eternal.
Reason 2: It’s Not Just About the Demand; Follow The Money
Knowing that the market will eventually return (more about that below), and also realizing that there are many billions of dollars chasing erstwhile distressed real estate, some will make the decision to build instead. It is difficult to get major distressed deals closed, and there aren’t nearly as many true opportunities as many thought there would be. For example, so called core product (substantially leased) is now trading at pre-2007 levels in many US cities.
So what’s a poor financier with a couple of billion supposed to do to earn his fees? Why, we thought you’d never ask!
Tenant demand is only one factor in the buy, build or hold equation. Follow the money, and those behind the money. When you do you will see that capitalism drives projects and creates entrepreneurial zeal (yes, we know you might call it something else). Money will find a way into commercial real estate, and for at least some, that will be by going vertical and creating new product.
Reason 3: Big Tenants Drive Markets
Speaking of tenant demand, there will, in fact, be some of that again. It’s not like corporate America shuttered the store and will never return. We are hearing an increase in interest in build-to-suits by very large tenants due to large or highly specialized needs.
The next wave will also be created by large companies who can’t find the perfect solution for their requirement. Perhaps some will start with a so-called forward build, but this activity by very large users will eventually lead to developers creating speculative buildings in hopes of catching some of the activity. Small users pay more and fill in the gaps, but large users, and the hope of attracting them, make developers take enormous risks. Occasionally, those risk pay off for those with an unusually high tolerance for risk and aggressive bankers’ demands.
Reason 4: They Don’t Make ‘Em Like They Used To
And thank goodness. We’ve written in this space before about the buildings from the “wavy ’80’s,” and earlier generations. Corporate users today are not only
looking for inexpensive real estate, they are looking for modern floor plates, green buildings, and the latest amenities. As many owners are finding, it can be hard and expensive to make an existing building fit this mold.
If you begin to dissect any submarket in America building by building, you will discover a fair percentage of the product is functionally obsolete, or close to it. As we heard an investor say once, these are “high tide” properties that only lease when the market is near its peak.
So given the appetite for newer and more efficient buildings, some will march ahead and break ground. Besides, there is precedent in many markets around the country for so-called “first mover advantage.” Those that create the newest, coolest product first will make the sale (this works in shoes too, by the way).
Reason 5 The Wall Street Journal Says So
Well, sort of. Ok, they said it will be years till we recover in commercial real estate with “much pain is yet to come” but they also suggest that “Pressures on rents seems to be easing.” All this is in an October 5th article entitled Signs of Recovery for Office Market. “In a sign that the country’s commercial real-estate market is finally turning the corner, new statistics show that office rents that have been falling throughout the economic downturn are beginning to stabilize” reports journalist Anton Troianovski.
The article does go on to talk about – once again – all the pain to come in commercial real estate (sip some more Red Bull), but we bet developers only hear the good news on rents.
So, here’s to you Mr. Developer. Make it happen once again!
Thanks to Tony Wilbert who first suggested the idea for this post. He’s very sane to be in commercial real estate PR at Wilbert News Strategies.