Where Is Commercial Real Estate Headed?

I don't normally get involved in commercial real estate, but lately I've seen some trends that are sure to have some impact on the residential market as well. However, before I continue, I need to note that as with any type or real estate, there are often local conditions and variations that run counter to prevailing trends.

The concept of commercial real estate can be quite appealing. The idea of long term triple net leases where the tenant pays the taxes, insurance, and at least a portion of the maintenance can seem pretty good. The flip side of this is that when the property goes vacant, it usually is not rented the next month by someone ready to move in. It can be a few months if things go well, it can be many months or more if things aren't going well – and now, in many large cities, things are not going well.

Everyone is aware that some businesses have been damaged by the hideout-at-home thinking brought on by the Chinese flu. That is just one of the influences on the current market, but it may be a primary factor leading to several others.

The Rotten Apple

The problem causing the most angst nationally is the flight of residents from New York City. But it's not just the worker and consumer bees heading out of town. This urban abandonment along with restrictive regulations has caused some businesses to see up to an 85% reduction in revenue. This no way to survive.

Fixed expenses go on, and on. Site rent – something far from insignificant in Manhattan goes on. Many are just giving up and closing down completely. Commercial property owners in New York and other major cities are faced with shrinking demand and fixed payments of their own. Some have the resources to weather the financial storm. Those with insufficient capitalization could be facing a financial crisis of their own.

Multiple Factors

The Chinese flu has caused a couple of things to happen, First, the faint of heart are loathe to go out in public. Second, many with the resources are bailing on many major cities – not just New York – trying to avoid the dreaded flu. Then there are travel/quarantine restrictions killing off the tourist trade. If that doesn't hurt enough, many who used work in the shining skyscrapers are now working from a spare bedroom at home.

As the TV commercials say. “But wait, there's more!” Public safety has taken a hit in many areas as the increasing hostility toward law enforcement has brought about a reduction in their presence and a not-surprising lack of public confidence. That lack of confidence has been justified as the despised and ridiculed police have not been permitted to stop rioters and looters, even petty shoplifters, from doing further damage to many downtown businesses.

Logical Reaction

With all this going on, who can blame enterprises large and small from abandoning downtown and surrounding areas? We've even seen the mayor of Chicago begging companies like Walmart to stay in her out-of-control domain. It's like. what do they have to lose? Merchandise? Buildings? Employees lives?

It comes down to a simple business decision. And these decisions are made over and over again. Big companies with the resources simply close up shop and move to greener pastures. Mom and Pop shops sadly fade away. But the results are the same: empty storefronts, empty offices, reduced property values, and reduced tax base... and fewer places for those left behind to buy clothing and groceries, or eat out – making the area even less desirable. It is reported that there are a record number of rental units available in New York – and it's doubtful that the Big Apple is all alone.

What Happens Now?

Having escaped from New Jersey many years ago, it is astounding to me that denizens of New York are buying some of the few homes available across the Hudson River site unseen for more than the listing price – such is the desire of the of the affluent class to escape from the city. Others are left behind in a city many years away from recovery.

New York is just one of many urban areas to experience this exodus of the business community. Portland, Minneapolis and Chicago to name a few have seen businesses destroyed by angry mobs. Many never to be seen again. And others that are have not been destroyed are getting out while the getting is good.

Long Term Impact

So businesses are leaving urban areas. Those that stay have many remote workers with only occasional visits to the office. This is an unanticipated consequence of the Chinese flu that attacked our nation. With the necessity to disburse and the technology available to do it, we have found a new way of working and companies have found a more economical and efficient way of getting the job done. The cube farm may no longer be the dominant home of the information worker.

There is a long term reduction in the demand for office and retail space all over the urban landscape. This will impact the real estate market, the financial market, and the housing market. The time is not to panic, but to plan – plot and scheme, perhaps - if you are in the commercial real estate business.

The Opportunities

As the old English proverb that says: It's an ill wind that doesn't blow anybody any good. Things are not going well, but opportunities still remain. A great many fortunes were made during the great depression. We have been told by people from Viktor Frankl to John Maxwell that what happens to us is not as critical as how we respond to it.

It is reported that Amazon is looking at putting distribution centers in abandoned mall anchor stores. There may be bargains to be found in the real estate itself – but it is only a bargain if you know what to do with it. This applies to small strip shopping centers as well as downtown skyscrapers.

We can't spend too much time listening to the media mavens of malaise. Remember, this is the country that played a large role in defeating the Nazi empire and the collapse of the Soviet Union. It is also the country that put men on the moon. If that spirit and determination has not been educated out of us, we will figure this situation out as well.

Evictions On Hold – For the Moment

President Trump has signed an executive order putting a hold on evictions. He is doing this to help ease the burden on working folks who have seen their income evaporate as businesses were shut down in a vain attempt to stop the spread of the Chinese virus. His heart is in the right place but this is a band-aid on only half the problem.

The Deeper Problem

While it is helpful for people not to be thrown out of their homes when their income stops, this does little to help the property owners who still have ongoing expenses like taxes and insurance as well as mortgage payments in many cases. This pushes the burden on other innocent parties hurt by the economic shutdown. The anti-capitalists in our midst may think this is the way it should be, that the wealthy landowning class take care of the so-called working class – as if the landowner sit around all-day drinking scotch and eating bonbons..

But this thinking comes from a lack of understanding of what is involved in providing housing in the community. Unless the property has been held for many years, there is probably a mortgage payment due every month, If rent checks stop coming in, it is difficult to keep payments going out.

This is not an argument for the government to write checks to the landlords. By the way, landlord is not a dirty word, no matter what some people try to make it sound. It is just a recognition of the economic truth: Their ain't no such thing as a free lunch. Somebody has to pay the check. In this case, the people providing the housing are asked to foot the bill. To Bernie Sanders followers this is entirely appropriate, but most property owners do not have an infinite supply of funds to support those that can't, or won't, pay the rent.

Eviction is not the Best Answer

In normal times, when people stop paying the rent (or mortgage payments) sooner or later the sheriff comes knocking on their door and out they go. When this happens the property owner is looking at several months (at least) of lost rent, along with legal expenses, and a rental unit in need of some work. This is even if the people being tossed out don't trash the place. Even if it is just paint and, possibly some carpet, it still costs money and another month of lost rent.

The Ticking Time Bomb

Unless the rent payments (and mortgage payments) are forgiven – that is written off, never to be paid – debt is piling up month after month. For the tenant who had been paying $700 to $1000 a month, if they haven't paid rent in six months, how will they pay back the $4,200 to $6,000 back rent when this madness ends? They may still be out on the street and the property owner will still be out the back rent, etc., etc.

A Sliver of Light

Fortunately, not everyone was put out of work or business. Many people kept on working and paying their rent and/or mortgage. As with every economic problem, some people thrived while others headed toward the bottom. Many online retailers saw their profits soar while small brick and mortar shop shut their doors – sometimes forever. While those deemed non-essential by the powers that be sat at home watching their bank accounts drain, those deemed to be “essential” kept chugging along, sometimes even enjoying a financial windfall.

Property owners with a variety of rental units many have a had a couple of tenants with issues even while most of the revenue continued. Smaller owners with few units saw their income remain or fall based on the fortunes of their renters. Even for those with sufficient cash flow to cover the missed revenue, we still have the moral issue that begs the question: should someone be forced to support another person who is not part of their family who cannot pay their bills?

Helping another person in trouble should be voluntary, not imposed from above by those with nothing at risk. This is a question many seek to avoid, and I will not go into all the ramifications of the various answers, but it is one that deserves consideration when we look at people deprived of the ability to earn their way in life.

Working Together

If the property owners and the renters work together in good faith, there may be some sort of reduced rent and partial payment deal to be had that benefits all concerned. Sometimes banksters work with property owners, but whichever side of the table one finds him or her self, talking about what is possible can help ease the burden on both. In fact, it is the only way to come out of this without either side being too badly damaged.

Neither side is the enemy. The property owner is simply supplying a place to live and the renter is paying for the value he is receiving. However, until we get back to the point where we recognize that all jobs are essential, except possibly that of some bureaucrats, and people can bet back to work without hearing the “OMG, we're all gonna get killed” mantra from the media, we will have to figure things out to get by.

Homestarts Are Up, Not Everyone Is Happy

I read recently where home starts in June were up 17.3%. This was after the terrible months of March and April with a small improvement in May. Existing home sales were down, but pending contracts were way up.

This seems like good news, but not everyone was happy about it. Aside from the political implications, there are some who see this as a problem. An appeals court recently dismissed a suit by the Edison Board of Education (NJ) against the Edison Zoning Board of Adjustment and a developer. This was over just an eight-unit project.

Why Would a School Board Sue the Zoning Board?

For those who haven't been involved in county-level politics, there are always various forces at work when growth is involved. Building new homes helps the area grow, however building new homes also puts more burden on local facilities such as schools, hospitals, and emergency services. Hence the actions of the school board who was put in a position of providing education for the children living in the new homes. There may have been other issues unique to Thomas Edison's home town.

Some will argue that the incremental costs of adding several students to the system are covered by the additional taxes (along with federal and state money). Up to a point this is correct – until they add up to the need for new schools, buses and teachers.

A Brief Explanation

I was involved in this for a number of years in the suburban Richmond VA area. It was an era when some in the county government felt it was their job to help the developers bring their plans to fruition, sometimes over the objections and welfare of residents negatively impacted by a hundred and twenty unit subdivision next to their rural home.

Emergency services could not guarantee expected response times if the development was beyond the planned growth zones. Schools hauled in classroom trailers to handle overflow, and a host of other situations came about by the influx of people. There was always this sense of conflict between the desire for expansion and those tasked with providing services.

One Solution

Because real estate development has an impact on the local government operations, the solution that was applied at this time was to implement something logically called an Impact Fee. The purpose of this was to help fund some of the additional services required by the increased population. This contributed to school and emergency service construction as well as road improvements.

This was somewhat helpful to the county but did not help the new home buyers. Between impact fees of something in the neighborhood of $20,000 to $25,000 per unit and various regulations, the builder had about $100,000 into a lot with nothing more than a hole in the ground. This wasn't the way to build affordable housing. The result was either townhouse construction to keep prices down or high-end homes near and over the million-dollar price tag.

The latter found several developments put on hold when the housing market tanked. Very nice homes were left by themselves with partially completed roads and partially completed neighbors. Builders took a financial beating.

The Other Solution

Others without the resources and connections, or opposed by powerful neighbors approaching the planning commission were simply turned down. Perhaps they were the fortunate ones. Occasionally one would slip through and the taxpayers funded the additional services.

The Big Question

What is the right thing to do with regard to development? There are two conflicting rights that need to be considered.

The first is the rights of the property owner to use their property as they see fit. This is a basic right in America. For some in this situation, their farmland was to be their retirement fund. The plans were to sell it to a developer and live happily ever after. For the county to prevent them from converting their property from farmland to residential was a financial hit that put them in an unexpected bind.

Counter to that right was the necessity of the county government to create viable comprehensive plans for growth and provision of service. What this means is that there are growth zones where services like police and EMT are within acceptable response times. Schools are available within a reasonable distance and growth in these areas is not a problem.

However, placing major developments beyond these areas meant excessive response times for emergency personnel and inadequate educational facilities. Thus the desire for impact fees that had such a negative effect on the whole process.

So the question: does the individual property owner's rights outweigh the cost and inconvenience of everyone else around them? I am loath to put the welfare of the government over the individual rights, but it doesn't seem that the individual, whether the farmer or developer can expect everyone else to contribute to their welfare and receive a negative benefit.

The Answer

This is where we see school boards and others creating obstacles to growth and development and it's not all about politics. Sometimes there are reasonable factors to keep in mind when bringing growth and progress to an area. Then again, sometimes the NIMBY people just don't want to see changes. There is no universal answer. Sometimes participation in local government can be a profitable pastime.