Today marks the end of the first half of 2024. Halloween decorations are already gracing store shelves.
Today, I thought it would be interesting to take a look at the predictions I made in January. It’s always a good idea to make sure you’re on the right track — especially when advising owners and occupants of industrial real estate in Southern California.
So with that as a backdrop, let’s review what I had to say six months ago, how those predictions are faring, and what’s in store for the balance of the year, shall we?
Prediction: Industrial lease rates will soften
This time last year, a client of ours was facing an expiring lease. We tried to find a suitable alternative to move his operation. Nothing was ideal.
We advised him to stay put, negotiated a short term fix for six to 12 months and continued our search. His owner would only agree to six months, so we had a new June deadline. We nearly struck pay dirt in March but jettisoned the opportunity due to its size. It just wasn’t quite big enough.
Once again, we approached the owner, asking for some more time. He agreed to extend through December. Our gamble paid off as we secured a suitable building at a 15% discount! Why, you may wonder? Simple economics.
We tracked new avails and ones leaving the market and noticed an imbalance. More was coming than going. We knew someone would drop their rate to secure a great tenant. Expect more of the same this year, especially with Class A buildings above 100,000 square feet.
At last count in Orange County, we had 11 open for business and seeking a resident. Two left the market last year. Someone will get motivated and make a deal, comps will reset to the new level and the frenzy will begin.
What’s happening now
If you read my column from last week, I discussed the stages in which price reductions occur.
In this scenario, owners looking to get their industrial buildings leased are offering more concessions, such as free rent, enhanced brokerage fees and potentially moving allowances to attract occupants to their vacancies.
Expect this trend to continue until all Class A inventory above 100,000 square foot is absorbed. How long will it take, you may be wondering? It’s difficult to say, but I suspect by February or March next year, we’ll be in a short supply situation again.
Prediction: Sales volume will increase
The forces outlined in the paragraph above will trickle into the sales world. By that, I mean an owner waiting for a tenant may choose to sell. Another catalyst could be the underlying debt on the asset.
Imagine you’ve originated a short term construction loan to build a Class A structure. You considered construction costs, time to build and lease. Your calculus was based on conditions in early 2022.
You’ve delivered a new building into an entirely different market with longer vacancy and lower rates. Your lender might be getting a bit nervous. When will the maturing debt be repaid? Thus, there’s new pressure to dispose of this new build.
What’s happening now
In the inland areas of Southern California, such as the Inland Empire, we are seeing some institutional owners opt to sell their vacancies as opposed to waiting for that elusive tenant.
In this manner, they are able to redeploy the money into a different market with better fundamentals or return principal investment to their investors. If a building has near-term vacancy meeting a year or two, expect this trend to continue.
Prediction: No recession
For a year now, I’ve taken a contrarian approach and predicted we would avoid a recession last year and this year.
Recall, recession is a decline in gross national product for at least two quarters. I believed in the resiliency of the United States economy, especially the consumer, and we skated by a recession in 2023.
As I write these predictions today, the only storm clouds I see on our horizon are global uncertainty in the Middle East. Specifically, will the Red Sea shipping lane disruption cause inflationary pressures on goods delivered?
If this proves to be the case, the Federal Reserve might be persuaded to delay cuts in interest rates, which are predicted for this year.
However, I’m reminded of our status back in January 2020. We were rocking along when a microscopic foe sent us to our spare bedrooms. Therefore, beware of the Black Swan event.
What’s happening now
So far, so good. In fact, aside from retail sales, our economy seems to be performing fairly well.
Unemployment has crept up slightly, but is still at historic lows. Granted, interest rates are higher than they were two years ago, but still much lower than we have experienced in other decades.
Will the Fed choose to cut interest rates later this year? Only time will tell, but I believe we may see an interest rate cut after the election.
Prediction: Interest rates will fall
Last year, for the first time in a couple of decades, you could actually make money on idle cash. We saw a peak in Treasuries last year when the 10-year T-note eclipsed 5%. The rate last week was slightly above 3.8%. This is good news for borrowers, bad news for savers, and could cause an uptick in institutional buying activity.
These behemoth money managers are constantly seeking return and might view commercial real estate as a safe haven to earn some additional juice.
I believe the 10-year notes will level at around 4 to 4.25% this year.
What’s happening now
As of this writing, the 10-year T note is hovering around 4.2 to 4.3%. This is significantly lower than the 5% we saw at the end of 2023.
As mentioned, Treasury interest rates are a great metric for savers but not such a good metric for those reliant upon borrowing — expanding businesses which need to lease space, buy a facility or machinery and hire. I still believe we will end the year with 10 year rates well below 4.5%.
I wish you and yours a very safe and sane Fourth of July. Let’s make the second half of 2024 the best ever!
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.
