Wednesday, January 25, 2017

Signs Of Rising Commercial Property In The Midwest

Midwest Property Market Showing Strength
Recently signs of rising prices for commercial property have started to appear in the Midwest. This trend seems to be driven by outside buyers coming in with cash. More and more I'm hearing of groups announcing plans to purchase and renovate buildings in my area. More often than not the numbers bantered around are substantial. This leads me to believe that with commercial property overpriced in so many other areas speculators are entering our market in search of bargains and fertile ground. No doubt part of this is the idea that those in charge of the economy actually want moderate positive inflation and “price stability,” not zero inflation as they have stated by having a 2% inflation target.

One strong and defensible argument for higher prices on current buildings is that replacement cost have soared. Part of this is due to new codes, regulations, and restrictions as well as higher material and labor cost. This is driving a trend to remodel rather than building new when a property is available. This means repurposing commercial buildings is becoming very common. The exception being many big box stores and franchises with Wall Street money demand new build to spec facilities. Another reason for money moving into this sector is that it is very interest rate sensitive and those buying today know when rates begin to rise the cost of money will create a strong barrier to new projects and construction which may cause rents to substantially increase. 

It should be noted that this game is closed to many of those who might want to jump in because the rules for purchasing commercial property are far different than what a buyer faces when acquiring a house for their personal use. Unlike buying residential property, commercial property tends to require buyers to pay some rather expensive fees in order to satisfy the lender's requirements. Expect a detailed "ALTA" survey to run thousands of dollars and the same for a commercial appraisal. On top of that expensive EPA test and studies to prove the property is not contaminated are often necessary, in the end, these expenses make buying and selling commercial property a difficult endeavor.

Most Investors Locked Out Of This Market
Decades ago many small independent businessmen with a vision and financing from a local bank set out to build their own building but this has become much more difficult. The lending rules and regulations noted above have halted this practice to a great extent. Over the years the commercial real estate market has become the dominion of Real Estate Investment Trusts (REITs),  experienced developers,  or speculators loaded with cash. The biggest players are the REITs, these are generally companies that own and operate income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels and even timberlands.

By its nature, commercial property investment bars many individuals from direct entry and today only experienced or wealthy players can get into this rather illiquid field where it can take years to sell a property. Deep pockets and a strong stomach are required to survive knowing that when a tenant moves out during a weak economy or soft market a building or office suite may sit empty for years is not something for timid investors. The cost of carrying vacant real estate is heavy and the burden great. Mother nature with the hot summer sun and her cold winter storms all take a toll. This means good solid buildings are often demolished to save on taxes, maintenance, and even insurance. In such a case the owner can only hope the land has enough value to salvage his investment or that he can construct a new building for a long-term tenant with impeccable credit.

Before you get excited and declare the strengthening prices in this sector of the economy as proof we have turned the corner towards prosperity it should be pointed out the speculation aspect of this trend is troubling. It might also lead one to ponder the possibility that we are in the final stages of a bubble that will eventually burst leaving many properties in default and the economy in dire shape. The bottom-line is that even though some retail properties such as malls have suffered recently we are beginning to see prices rise and stronger price underpinnings even in areas where prices have struggled for years now the question is whether these increases are justified.

Footnote; An article I wrote several months ago reflect on the fact that some of the commercial real estate frenzy occurring in my area is driven by government. One of the several projects proposed in the city where I live is not out of line with what is happening across much of America. We should all be concerned at how financial restraint is being cast aside to create cookie-cutter cities and an illusion of growth. Below are some of the details of what is occurring in the city where I live. When all is said and done I fear the taxpayers will be presented with a bill for these boondoggles and the current exuberance.

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