To hear the ad team describe it, 1372 South California Blvd. in downtown Walnut Creek, Calif., Is the perfect investment property. It is a 25,520 square foot two-tenant commercial building with a high-performing Trader Joe’s and Pet Food Express mainstay, backed by a CVS credit. Sansome Pacific Properties was the seller, represented by Putnam Daily, Lindsey Snider and Michael Maffia with Preserve West Capital.
“There is an incredible demand for well-located, high-quality net rental retail investments anchored by high-volume grocery tenants like Trader Joe’s,” Daily said at the time of the sale. “With a limited supply of opportunities in this space, especially those with long-term development potential, we have met as much demand and interest as we have had in an opportunity over the past decade. “
After receiving several offers in the first week of marketing, Sansome Pacific Properties selected Loja Real Estate, who paid the full asking price for the property.
An ongoing standoff
The sale of Sansome Pacific is just a data point, but telling.
Buyers and sellers of commercial real estate entered the pandemic with their usual gap in price expectations, then refused to move closer to each other despite the market turmoil. Granted, there were hardly any transactions at the start of the pandemic to judge whether sellers were ready to cut prices. But as the pandemic progressed and markets started to move again, it became clear that sellers weren’t ready to fold. Now, with the CRE markets recovering, it looks like they are doubling down on this position.
This is largely due to the demand for certain assets. Buyers have focused most aggressively on the properties that have resisted the pandemic the best, namely those in the industrial, multi-family and self-storage sectors. Investors have also targeted types of properties that are expected to recover quickly from the crisis, such as hotels as well as certain types of businesses and senior housing, according to a Marcus & Millichap report. “Although some discounts have occurred in unique situations, the valuations of most types of assets have remained largely stable or have exceeded pre-health crisis levels as strong buyer interest has subsided. aligned with limited inventory for sale, ”the report says. “This momentum has also led to a compression of cap rates among sought-after assets.”
Change of dynamics
There are signs, however, that sellers do not have all of the pricing power. Commercial real estate price growth, as measured by the RCA Commercial Property Price Index, is expected to remain below the 5.2% of 2020 over the next three years, falling to 4.2% in 2021 and increasing to 5% in 2022 and 5% in 2023. time, the volume of commercial real estate transactions is expected to recover relatively quickly until 2023, reaching $ 590 billion from $ 500 billion in 2021, according to the Urban Land Institute . Last year, the volume fell nearly 30% in 2020 to $ 427 billion from a post-Great Financial Crisis peak in 2019 of $ 598 billion.
Prices will also be affected by rental growth, which is expected to vary by asset type but will generally continue to improve over the next several years. ULI predicts that this year industrial and apartment rental growth will be 4% and 1.7%, respectively, while retail and office space are forecast at -2% and -2.9%, respectively. .
There is also the wild card of the multiple tax proposals from the Biden administration that could affect commercial real estate. While these have yet to go through what is sure to be an arduous lobbying and negotiating process, some experts predict that more investors may be inclined to sell before these proposals become law.
For example, the administration proposed to increase the capital gains tax from 20% to 39.6% for households reporting income above $ 1 million. However, Bitner predicts that this tax increase will eventually land at 28%. David Bitner of Cushman & Wakefield, global head of capital markets research, believes investors will be incentivized to sell before these changes occur, although he believes the change is likely to occur in the near future. during fiscal year 2022. In a report, he speculates that these changes could make a sale more attractive to investors who are already considering divestments. In addition, long-term holders whose gains have not yet been realized may also consider selling if they do not think market conditions are clearly unfavorable.
The administration’s proposal to eliminate like-for-like exchanges for earnings greater than $ 500,000 could also push buyers out of the market, said ResMan founder and president Elizabeth Francisco. “Similar trading rules encourage investors to stay invested in real estate. Prior to bringing ResMan to the market, we handled 1031 exchanges. Within our portfolio we had several assets which were purchased from a new construction developer who used the proceeds from the sale to finance the development of new apartment communities.
However, one should not neglect the stubbornness of the sellers, even in the worst of markets. Last year, the divide between buyers and sellers of commercial goods not only remained in place, but actually widened in the third quarter, straining sales, according to CBRE.
According to the study, while 61% of buyers expected price discounts before the pandemic, only 9% of sellers were willing to offer such price discounts. The new buyers’ criteria didn’t help. CBRE found that investors placed greater importance on the credit quality of tenants, which was cited by 85% of respondents, and both the remaining term of the lease and the occupancy of the building – which each accounted for. 64% of respondents – than before the pandemic. .
A story of market by market
That said, each transaction has specific factors that may favor a buyer or a seller, despite the broader market trends. Commercial properties aren’t necessarily high on investor wish lists right now, for example, but as Sansome Pacific Properties has shown, some assets can be fiercely sought after even in this market.
“It depends on your location and the type of product,” says Edward Easton, President of the Easton Group.
“So far there was a big gap. Properties weren’t traded that often, ”he says. But some areas have shaken in his region of origin. “In the Miami industrial market, the supply and demand are not very far apart, and buyers are making offers,” Easton adds. “This is also somewhat the case in rental housing. I don’t think that’s the case in retail.
“In our world, the gap between supply and demand has narrowed over the past six to 12 months,” adds John Feeney, senior vice president of The Boulder Group, which focuses on single-tenant commercial space. But while some things loosen up, others don’t.
Casual restaurants, gyms, movie theaters and the like have taken the pandemic on the chin and have been taken off the roll. Investors did not want to touch them, “especially in retail and hospitality, but also in offices and collective housing,” said Lisa Knee, partner at accounting, tax and consulting firm EisnerAmper.
“With so much equity available for real estate investing, there is huge competition for transactions,” Knee said.
For Boulder Group, popular properties have been drugstores, grocery stores, and other essential businesses. The result was a lower overall supply, creating what appeared to be healthy demand. This has led to the split of supply and demand.
“I’ve lost options, so there are going to be other people who will do the same,” Feeney says of the reality of buyers.
In the Southeast, even land has seen high selling prices, according to Hunter Suggs, director of commercial real estate in South Carolina for National Land Realty.
“The increase in land prices over the past nine to 12 months in the Southeast can be attributed primarily to increased demand from single-family developers and builders, as well as multi-family developers, for these quality sites that tick the right boxes, ”he says. . “The implications of soaring land prices are sellers with high expectations, but at the same time we see a certain percentage of developers / builders willing to pay the top price for the best land positions. “
But while many homeowners have resisted the price they want, many may soon have to abandon the strategy.
“The bad news is that more than $ 400 billion in commercial and multi-family debt falls due this year,” said Marina Vaamonde, investor and founder of PropertyCashin.com. “The government’s stimulus package cannot last forever. The release of the 2020 census data shows an increasing flight from large metropolitan areas and an increase in inflation is expected by many economists. “