Will investors return to commercial property this year? Watch interest rates – Orange County Register

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One of my predictions headed into 2024 is that we’ll see an uptick of buying activity, especially from institutional purchasers.

Why, you may be wondering? Here are my three reasons.

Number one: Most industrial sites haven’t transacted since the middle of 2022 and must in order to balance allocations.

Number two: We should get clarity this year about one of the metrics that determine commercial real estate value — rental rates.

Number three: A declining interest rate environment  will make Treasury bonds less compelling and real estate more so.

Allow me to add color to these three reflections. But first, a quick review of my definition of an institutional investor.

If you’re a teacher, firefighter, police officer or work at city hall, you can relate to the portion of your paycheck that’s deducted to fund a retirement.

Before the predominance of 401k funds, private employers also provided pensions and took a slice of your salary to do so. If you pay into a whole or universal life insurance policy, those premiums must be invested as well.

All of the above form pools of capital that are used to buy stocks, bonds money market funds and commercial real estate and then produce returns for their investors. Each asset class has its own percentage the fund managers dictate.

Advisors — at the direction of fund managers — use these funds to make purchases. Thus, an institutional investor.

‘Pencils down’

When we began 2022, institutional interest in commercial real estate was rabid, especially if you owned and operated a company from your building. It wasn’t unusual to have buyers knocking on the door.

The play two years ago was to buy the real estate and provide the occupying company a lease-back of around two years.

Demand during this period of time drove values to unseen levels. In some cases, buyers were willing to pay double. The theory was that by 2024, rental rates would far eclipse the lease back amount, providing a greater return on the investment.

However, when the Federal Reserve started to hike interest rates in the middle of 2022 — coupled with global uncertainty —  we saw a shift in investor attitudes. The term, “pencils down” permeated the industry.

For the entirety of 2023, this outlook continued and institutional investor activity was reduced to a trickle.

Where are rents?

One of the fundamental metrics in the world of commercial real estate is rental rates. Think of it as the heartbeat of the industry.

The coming year holds the promise of clarity in this crucial metric. As I’ve written in the space, rents in Class A industrial in north Orange County seem to have found a level that has spurred demand.

So why is this so important? Imagine you’re considering buying a commercial property. You need to know how much rent you can expect to charge tenants. If this number is vague or uncertain, it’s akin to navigating in the dark. But when you have a clear picture of expected rental rates, it’s like having a bright guiding light.

Clear rental rate data allows investors to make informed decisions. They can assess whether a property is undervalued or overpriced, which ultimately impacts the return on investment. It’s the linchpin that can make or break a deal.

Interest rates

Now, let’s talk about something that affects every investor’s decision-making process — interest rates.

In 2024, we’re looking at a landscape of declining interest rates. But why should that matter for real estate?

Picture this: You have some money to invest, and you’re considering your options. On one side, you have Treasury bonds, historically considered a safe bet. On the other side, you have commercial real estate. Traditionally, when interest rates on Treasuries are high, they’re a compelling choice because they offer a relatively safe and stable return.

However, when interest rates start to drop, as they’re doing now, the risk ratio changes. Suddenly, the returns on Treasury bonds become less appealing, while the potential returns from real estate start to become more compelling.

Investors look for opportunities that offer higher returns, and that often leads them to the commercial real estate market. In a world where real estate can provide solid returns in a low-interest environment, the appeal of this asset class becomes evident. It’s a shift that institutional investors can’t afford to ignore.

So, to sum it up. The year holds the promise of an exciting time for commercial real estate.

Institutional investors, with their careful balancing of allocations, eagerly await clarity on rental rates as they navigate the changing interest rate landscape. These factors, when combined, create a compelling case for increased buying activity.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.

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