Two industrial buildings in Anaheim recently sold for $18.5 million. (Photo courtesy of CBRE)
One of my predictions going into 2024 is that we will see increased buying activity, especially from institutional investors.
You may be wondering why. Here are three reasons:
First: Most industrial land has not been traded since mid-2022 and transactions need to be made to balance the allocation.
Second: This year we should get a clear answer on one of the indicators that determines the value of commercial real estate: rent.
Third: As interest rates fall, government bonds become less attractive and real estate becomes more attractive.
Let me expand on these three observations in a bit more detail. First, let's briefly review the definition of an institutional investor.
If you're a teacher, firefighter, police officer or city employee, you understand the money being withheld from your paycheck to fund your retirement.
Before 401k funds became popular, private employers also offered pensions, for which you would take a portion of your salary.If you have whole or universal life insurance, you should also invest that premium.
All of the above are used to purchase stocks, bonds, money market funds and commercial real estate to form a capital pool that will generate profits for investors. Each asset class has its own percentage, which is determined by the fund manager.
The advisors use these funds to make purchases as instructed by the fund managers – i.e. the institutional investors.
“Put your pencil down.”
As 2022 began, institutional interest in commercial real estate was very high, especially if they owned and operated a company in the building, and it wasn't uncommon to have buyers knocking on the door.
The plan two years ago was to buy the properties and offer leasebacks to tenants for about two years.
Demand during this period drove property prices to unprecedented levels. In some cases, it even saw buyers willing to pay double the amount. In theory, by 2024, rentals would far exceed leaseback amounts, resulting in even higher investment returns.
However, as the Federal Reserve began to raise interest rates in mid-2022, coupled with global uncertainty, investors' attitudes began to shift. The term “put the pencil down” permeated the industry.
This outlook has continued through 2023, with institutional investor activity becoming negligible.
Where is the rent?
One of the fundamental metrics in the commercial real estate world is rental rates. Think of rental rates as the heartbeat of the industry.
Next year will likely provide more clarity on this key indicator: As I’ve written in this column, rents for Class A industrial land in north Orange County appear to have reached levels that could stimulate demand.
So why is this important? Imagine you're looking to buy a commercial property. You need to know how much rent you can charge your tenants. If this number is vague or uncertain, you're navigating in the dark. But if you're clear about what rent you expect to charge, it's like having a bright guiding light.
With clear rental data, investors can make informed decisions. They can determine if a property is undervalued or overvalued, which ultimately impacts the return on investment – which can make or break a deal.
Interest level
Now, let’s talk about something that influences every investor’s decision-making process – interest rates.
Interest rates are expected to fall in 2024. But why does that matter for real estate?
Imagine this: you have money to invest and you're considering your options. On one side, there are government bonds, which have historically been considered a safe investment. On the other, there's commercial real estate. Traditionally, when interest rates on government bonds are high, government bonds are an attractive option because they offer a relatively safe and stable return.
But when interest rates start to fall, as they are now, the risk ratios change. Suddenly, the returns on government bonds become less attractive, and the potential returns from real estate start to look more attractive.
Investors are looking for opportunities that will generate higher returns, which often leads them to the commercial real estate market. In a world where real estate offers solid returns in a low interest rate environment, the appeal of this asset class is clear. This is a change that institutional investors cannot afford to ignore.
In summary, this is shaping up to be an exciting year for commercial real estate.
Institutional investors are awaiting clarity on rents while carefully adjusting their asset allocations to accommodate the changing interest rate landscape. These factors combine to create a compelling case for increased buying activity.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange and can be contacted at abuchanan@lee-associates.com or 714.564.7104.