Commercial Real Estate 2011: Opportunity Returns
With corporations earning record profits and lease deals still available, opportunity and growth will return to the commercial real estate sector in 2011.
Thomas J. Stringer, Esq., Managing Director & Practice Leader, Site Selection and Business Incentives Group, BDO USA (2011 Directory)
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Old-fashioned opportunism is also driving the market these days. Proactive leasing tenants are extending existing leases to capture lower rental rates while extending the term. While this helps tenants reduce operating costs by buying cheap, it simultaneously gives landlords certainty in showing their lenders that their buildings can be financed, remortgaged, and have a strong cash flow. This is increasingly the case in the Northeast, where activity is off of its rental rate highs. Vacancies are not as high as expected two years ago in central business districts. Both sides of the table win in these transactions, and both are buying certainty and cost control.
On the entrepreneurial side, many owners and speculators are returning to the market by buying the notes on buildings at significant discounts, presenting new tenants with deep rental discounts. This has been a trend in several Northeastern suburban markets, especially in Long Island, New York.
Proposed changes to accounting rules will turn expense items like leases into liabilities on a balance sheet. When first proposed a year ago, some said this would dampen the commercial real estate market. As tenants sought to avoid hundred million dollar liabilities on their balance sheets, it's expected that they would seek to either take short-term leases or alternatively buy buildings. The current purchasing of buildings is a refreshing sign, as it also drives transactions, commissions, fees, new taxes, and salaries. Companies hoarding cash for the last two years find investing in a physical structure a safe bet and a conservative choice going forward.
This has given many in the commercial brokerage community and existing landlords cause for concern, as they speculate that lease terms and values will decline. But not every tenant is equipped to be, nor wants to be, a landlord. Thus, deals will still happen. Secondly, the major accounting firms are already seeing compliance and reporting for these new rules as a boon, like Sarbanes-Oxley once was. They are preparing their audit departments to account and bill for this.
So the real concern is the effect this will have on a landlord's ability to finance if terms decline from a standard 10-year lease. This will alter deals in form, but is unlikely to stop them or materially change the business.
Some locations are seeing the decline in property tax rates and costs as an economic advantage. In the Northeast, rental rates have dropped significantly from 2007 highs. Many companies, for the first time in decades, are seeing relatively affordable real estate costs, but stagnating labor rates. Does this make up for other cost factors like higher tax burdens, utilities, and other site selection factors? Not entirely. But it is a silver lining for landlords, brokers, real estate directors, and economic development officials. Northern locations and cities can increasingly complete with suburban and southern locations on merits.
So all is surely not lost in commercial real estate. While we may not make up all of the recession's losses in 2011, burgeoning trends will help on the way. Aggressively managing a portfolio along these lines could lock in cost savings for years to come when the market starts its inevitable climb.