Timid Investing in Commercial Real Estate With Potential Recession Looming?

With the stock market’s instability due to a post-pandemic hangover from the flood of money/debt shot into the economy which created labor shortages and supply chain disruptions; the rush to abandon fossil fuels; and the Russian/Ukrainian war, investors are either entering, or currently thinking about entering, the commercial real estate market are wondering if that’s a good idea right now. And, if they do enter the commercial real estate market, which type of property should they consider?

Although rising interest rates are posing a risk to economic growth, NAR chief economist Lawrence Yun expects the commercial real estate market to perform well despite the headwinds, especially in the short term. Despite the office sector, which is lagging as employers allow increased remote work/flex time to keep and attract talent, commercial real estate continues to strengthen, especially in areas of positive population growth, like Austin, Texas, and its surrounding communities. The larger Class A office proprieties have fared better than the smaller, older, suburban Class B and C properties since the tenant make up of Class A office properties typically consists of corporate businesses, in particular technology companies as in the case with Austin.  These larger corporations are “carrying” office leases they don’t need today with the expectation their employees will return to the office on a more regular basis.  And, as has almost always been the case, the large Class A office buildings are prime targets for institutional investors, who are looking for multi-million-dollar property to put in their portfolio for the long term. For the individual investors, I would advise caution when contemplating buying an office building, especially one located in a suburban area.  The reason is businesses that make good prospects for these types of buildings are finding the work from home environment is saving them on operating expenses and, as long as the employees productivity remains high, these employers are less in a rush to migrate employees back into the office.

Industrial properties of all types continue to be strong investments, particularly distribution and manufacturing facilities as the corporate supply chain has been adapting to a “just in case” model which requires more storage of goods and a nimbler manufacturing process.  This model is being echoed across the country.  Of all the commercial real estate investment types, Industrial property is typically the least expensive per square foot. It also typically yields the least amount of rental income, but for that reason it is the most affordable investment type.

Retail properties appear to have turned the corner post-covid as consumers are getting out to “brick and mortar” shopping.  Be careful when evaluating a retail property with vacancy.  You want to do solid due diligence to try to determine if there is demand for that vacant space.  Location, visibility, accessibility, curb appeal, ample parking are all important factors in attracting a quality tenant. As with any commercial real estate investment, have plenty of cash reserves since you could be looking at potential prolonged vacancies.  But, at least in the case of a retail property, the tenant typically pays for things like buildout, interior maintenance, and air-conditioning maintenance.

For those investors looking for direction on current cap rates, it appears cap rates for all classes of property are one to two points above what they were pre-pandemic.  For example, retail property pre-pandemic cap rates were around 4%.  Now, cap rates for those same properties are running around 5.5- 6%. That’s mainly due to the continued uncertainty about a 100% full post-covid recovery and strong potential for a recession in the near future.

Finally, single and multi-family investment properties, which long have been good investments through recessions, continue to perform well especially in positive population growth markets like Austin, Texas.  This is truer than ever with the Covid and post-Covid shift of many people working part/full time from home.

So, if you are considering buying or selling commercial real estate, give me a call.  I would be happy to talk further about your investment strategy.

My cell is 512-736-5933.

Chris Oddo, Broker