Everybody knows commercial real estate has taken a beating, right? Offices are empty because of the migration to work-from-home, and shopping malls are reeling from e-commerce — or so the common wisdom goes.
Not so fast, says Cedrik Lachance, executive vice president, director of research with Green Street, who exploded those and other myths at a recent commercial real estate outlook webinar. California-based Green Street provides commercial real estate research, news, data, analytics, and advisory services.
While commercial real estate has suffered setbacks, there are plenty of opportunities for investors in both the public and private markets — including the office and mall sectors, Lachance said.
“What’s often presented is a picture of the office business as being all of commercial real estate, when, in reality, there are far more sectors we can play in where perhaps many activities will be better,” he said.
The greatest potential for surprise
Overall, property values in the office market have declined 31% from recent highs, and “REIT-quality,” or average, office properties have fallen 40%. It will take “quite some time” for the sector to recover, he said.
But asked which commercial real estate sector has the greatest potential for surprise, Lachance’s answer is, well, surprising.
“Office,” he said. “Just because it’s so negatively slanted, so it doesn’t take a whole lot.” The bright spot he sees in the beleaguered office sector in “high quality” office.
“I would argue that the office business could actually have more supply, which probably made you stop for a second, “said Lachance. “The reason for that is high-quality office is in great demand. And so being a developer for office is still prospectively a value-creating endeavor, even if it has negative outcomes, of course, on B-quality office, and sometimes even other A-quality offices.”
Retail also deserves another look
Similarly, the common wisdom on retail properties — shopping malls and strip malls — is flawed, Lachance said. Green Street recently upgraded the outlook on more shopping malls than it downgraded, he said, noting, “It’s been a while since we did that.” The shopping mall sector has “absolutely stabilized if not gotten a little bit better,” he said.
“Anybody who still looks at the mall business as, ‘Hey, it’s troubled and it’s losing versus the internet,’ really needs to start looking at how the dynamic between e-commerce and in-store purchases has evolved,” he said, noting that the retail business and the mall business have become “substantially more attractive.”
Stores are playing a big role in e-commerce purchases. They’re serving as distribution hubs and offering shoppers a convenient location to pick up and return online purchases. And of course, once they’re in the store, they may buy more items.
“We really need to retool our minds basically when it comes to retail,” Lachance advises. “Think of it as having gone past that big storm and being a very interesting potential investment.”
The retail business continues to see “hardly any” new supply, and that lull in construction has been a boon, Lachance said. “When you do this for several years, as it’s appeared, it’s a real positive for the market.”
Although the webinar was directed at private investors, Lachance said that the best opportunities for mall investment are in the public market, including publicly traded REITs.
Self-storage, data centers and more
Another troubled sector worth a second look is self-storage, which has been experiencing a readjustment in rents after a period of underperformance, Lachance said. That could continue for some months, “but as an entry point, it’s starting to be more and more compelling, appealing,” he said.
The data center, fuel storage and industrial sectors have “very, very positive” expectations over the next five years for market rent growth in some cases, and some occupancy gains.
Lachance said there’s a perception that commercial real estate lending is tight. While that’s not entirely true — some sectors, including data centers and industrial have a “wide-open door” to credit — commercial real estate in general has a property overvaluation problem that gives lenders pause, he said.
“Until valuations are presented in a way that’s more reasonable and more realistic, versus where we are, it’s going to be harder for asset-back lenders — for commercial real estate lenders — to be more productive providing loans,” he warns.
Data centers, which experienced declining rents, now have a positive outlook as artificial intelligence grows in importance, Lachance said. He notes that Green Street is “very positive about the prospects for rent growth overall in the data center business with a lot of ability to push rents in some of the key top markets in the U.S.”
Housing hot spots may not stay so hot
In his review of housing markets, Lachance said the Sun Belt remains a bright spot, but climate storm clouds may threaten that picture. A number of Sun Belt hotspots, including Miami, Orlando and Fort Lauderdale, are in the top 10 U.S. markets, and there is a good prospect for rent growth, he said.
But climate change-fueled natural disasters are driving up insurance costs for commercial real estate in Florida, California and other Sun Belt areas. And insurance is affecting the cost venturing real estate “really, really quickly,” he said.
“We are seeing effectively a broad forward of the costs of climate events that I think a lot of us would have factored in over a much longer period,” Lachance said.
“Operationally, even if (insurance cost increases) can be passed to tenants for a period of time, at some point, this is going to hit the landlords as well, because everyone will eventually share in that vein for total cost of operation from the tenants’ perspective,” he said.
And as the drumbeat of disasters continues and home insurance costs skyrocket, some people will decide against relocating to the Sun Belt, and some already living there may move away, he warned.
Public-market cues
During his presentation, Lachance repeatedly referenced the public market, both as a bellwether that private investors should watch for insights on commercial real estate, and as a better avenue for investment in certain sectors. The public market offers an “incredible benefit” in expressing an opinion on values in real time with capital flows, he said.
For example, he said private investors should heed the public market’s position on office sector property values, which many believe remain too high.
“But the public market over the last eight to nine months is saying, ‘I think we’re good value. I think we’ve declined enough now,’” he said. “It’s important to note that the public market is no longer reducing its expectations for office, so there’s an element of stability that exists.”
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In residential real estate, Lachance is a cheerleader for the public market, which he said is “vastly cheaper” and a better place to invest than the private market.
“When you think, ‘I could be buying apartments, I could be buying, building single-family rental portfolios,’ yes, that sounds really cool to do at the private market. You’ll make a lot more money doing it on the public side,” he said. Residential REITs may specialize in apartment buildings, single-family homes, student housing or manufactured homes.
The reality
Overall, Lachance said, there is a perception that commercial real estate has gone dormant, that “there’s no transaction out there.”
“Well, we don’t see enough closing versus 2021 and 2022. There’s no question that the market was substantially more active the last couple of years,” he said. However, “When you think about real estate activity over the last decade, 2023 is shaping up to be more or less the same as what we’ve seen over the past decade. And so, when we look at the level of interest or lack thereof for real estate, it’s perhaps not as bad as people tend to think.”
In a four-decade career in journalism, Ed Prince has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune.
