The fact that market conditions have changed significantly in 2023 cannot be disputed. The decade long bull run we have been on has slowed to a walk, and visibility on the path ahead is, at least for the moment, limited.
Lease rates and sales prices remain near record highs, but the rapid growth in both has stalled, and it’s easy to see why. The economy is under tremendous stress due to persistent inflation, deficit spending, polarized politics, trouble at the banks and aggressive monetary tightening by the Fed, all of which has caused considerable confusion in the commercial real estate industry.
In just the past 18 months mortgage rates for industrial properties have more than doubled and lenders have tightened underwriting metrics making it difficult to borrow even at the higher rates. Yet, as we have been reporting for months now, sales prices have not corrected to make up for higher borrowing costs. That, we believe, is due mainly to the lack of available supply, as owners have been reluctant to sell and face the tax consequences of realizing enormous gains.
Which brings us to the point of today’s post. Most owners are sticking with disposition plans they made decades ago, despite the fact that everything has changed around them. Put another way, they are thinking statically in a dynamic situation.
Let’s say you bought your building when you were in your mid-forties for $75 per square foot in 1998. It has served ably as a home for your business since. It rose nicely in value until 2007, and then took a big dive until 2011 when another bull market began. You enjoyed the meteoric rise in its value each year since, and you’ve probably had a chuckle or two when brokers kept sending you unsolicited offers at ridiculous prices. But you rejected them all because your business needed space and you were not ready to retire.
Fast forward to 2023. You are now in your late sixties and you are probably thinking about retiring and focusing more on quality of life issues. Your business has probably changed significantly and your space may not support your operation as it once did. The unsolicited offers no longer arrive in the mail, but the inflated invoices from your vendors still do, and they make you wonder just how long your business can take the pressure of inflation. But, you keep hanging in there, sticking with the plan and hoping things get better.
If this resonates at all, take comfort in knowing that you are not alone. We speak to property owners every day who have this experience. They are not quite sure what to do, so they stick with the original plan for their property, hoping for the best. Even though they could cash out with an enormous pile of after-tax cash, exchange into a lower-risk property to hold for income in retirement, or some combination of both, they stick with the decades-old strategy they started with. For those who have other means to fund retirement and just want to give the property to heirs when their time comes, that is a viable strategy. But, for the majority of small business owners who own their buildings, their property figures heavily into their retirement strategy.
If you are one of those owners, this may be the time to shift to a more dynamic approach and consider where your unwillingness to change course might take you. Every dollar of lost equity in the event of a market correction, is a dollar not available to help you pay your capital gains taxes if you sold today. That’s just one way to look at the situation. There are many others we can help you consider. Our goal is to help you do the right thing for you, whatever that is and even if it makes us appear opportunistic.
Unfortunately, we have been around long enough to have seen fortunes gained become fortunes lost. As the old saying goes: Buy low, sell high. You got the first part right, and the choice is still yours to get the second part right.
A final thought: when markets correct, they tend to do so suddenly. Unfortunately, we’ve been around long enough to know that, too.