Is It Still Wise to Buy in a Hot Market?

The demand for industrial real estate in Orange County is still running high and that has many of our clients asking us about the sustainability of the run-up in property values that has returned the market to peak levels of 2007. They wonder:

Is it still a good time to get into the market as an owner?

The answer depends on several variables.

Let’s take a look at a few of them to shed some light on what might be best for you in the long run.

Evaluating Risk

First, the veracity of any investment can only be determined by comparing it to the alternatives available in the same time frame.

If the yield on a “no-risk” 10-year US T-bill is 2.1%, as it is today, it makes little sense to get into an investment that returns just 3%, but carries with it considerable risk. The spread or “premium” over that theoretically risk-less asset is what determines the price investors will pay for any particular asset. That premium is subjective and each investor must assess his or her own individual appetite for risk.

So, when it comes to investing in commercial real estate, you must decide what your risk premium must be before you become a buyer. For the most aggressive owner/user buyers, the risk of a price bubble is offset by the lowest cost of capital since Eisenhower was President.

Lease Period

Functional utility, efficiency, and control of occupancy cost for up to 25 years mitigate the risk of a price correction for business owners who believe they can use the same facility for five to ten years. That long term perspective emboldens them to pay a price that is higher than the previous sale and even higher than anyone else has ever paid for the same product.

For some, that is just a bit too scary, and they opt for the flexibility that comes with leasing on a short term basis.

They are either more risk averse, or they see the potential of being stuck in a building that doesn’t suit rapidly changing space needs as too high to avail themselves of the benefits of ownership.

Creating a Multi-Faceted Plan

The point is: every business owner must develop a unique risk profile that is based on more than the fact that the real estate market happens to be on a roll, or is being defined as a hot market.

It has to be built on multiple variables specific to each owner’s unique circumstances, in addition to real estate market conditions.

Right now, it is becoming more difficult to find quality space, whether you are looking to buy or lease the next home for your business. The vacancy rate in Orange County and Central Los Angeles is now under 3% and it is still trending lower.

The lack of new development only compounds the problem, and that allows landlords to negotiate longer term leases with higher annual rent increases. Thus, more tenants are looking to buy, as the flexibility associated with leasing is compromised by the longer term.

Like every other business owner, you will be facing a real estate decision in the not-so-distant future. Which way will you go? What will you have to choose from when the time comes? How much will it cost? But, most importantly, consider what you can do now to prepare yourself to choose wisely.