By Joe Latina, SIOR & Chris Moore, LMT Commercial Realty, LLC/CORFAC Int’l.
As trusted advisors to our clients, it is more important than ever to stay updated on market conditions that directly affect every aspect of commercial real estate.
“If I were given one hour to save the planet, I would spend 59 minutes defining the problem and one minute resolving it.” -Albert Einstein
In an ongoing effort to combat inflation, the Federal Reserve continues to raise interest rates with conventional rates currently in the 7%-9% APR range and SBA loan rates topping 10%. Higher interest rates directly affect CRE developers and investors who have become accustomed to borrowing money at low single-digit rates. Many existing loans are now facing rate adjustments that are directly affecting the return on investment on previously acquired assets.
Cap rates for NNN investment products remain low, despite higher financing costs. Although there appear to be fewer buyers vying for investment products in the current market, cash and 1031 exchange buyers remain very active and there is a shortage of quality investment properties available.
Although construction costs have begun to ease slightly, they remain at all-time highs with exorbitant lumber costs. Many supply chain challenges persist: Construction materials such as transformers, electrical panels, circuit breaker panels, switch gears, storefront materials, and HVAC units are in high demand and short supply. Shipping charges for these products are also rising. We are starting to see improvements as many products historically manufactured overseas are being developed domestically. However, it will take time to open new manufacturing facilities and catch up to the backlog.
The approval process for new construction projects remains tedious with delays in obtaining final entitlements. Simple variances take a great deal of time and turnover within the approval agencies is contributing to the delays. This, coupled with additional carrying costs created by high financing rates and high construction costs, is driving current leasing rates into uncharted territory. The fallout from this 1-2-3 punch is being felt by the end users. Small to mid-size retail clients are struggling to afford or make sense of the high leasing rates.
Industrial/flex rates are beginning to stabilize after experiencing historic, post-pandemic rate increases. After enduring a near 30% rate increase in 2022, rates in our local market have remained in the range of $10-$15 per square foot NNN/annually this year. There is a shortage of quality industrial/flex space in the 2,500-20,000 sf range in our market. However, we are beginning to see some turnover as many pandemic-driven businesses are struggling to exist in the post-pandemic world. New construction is very limited, so vacancy rates remain very low.
Office leasing activity and rates remain at historic lows as employees continue to push back on returning to the office. Many CBD office buildings are being converted to urban apartments as the demand for this product remains high. Apartment rental rates continue to increase, with recent sales in our market reaching upwards of $200,000 per unit in some cases.
Hospitality growth remains stable with breweries and distillery-pubs leading the restaurant growth and many smaller, more efficient hotels being constructed in tertiary and expanded-resort areas.
Navigating through these challenges is no small task; however, understanding the sources of the problems is the first step toward making informed CRE decisions.
Joe Latina, SIOR, and Chris Moore are managing principals of LMT Commercial Realty, LLC/CORFAC International.