Beginning of the commercial real estate fall: we are now seeing price drops, missed bids and widening bid-ask gaps
We listed a 40-unit building in the East Bay a few months too late, and a mall in Silicon Valley. Here is what happened.
By John E. McNellis, director at a real estate developer McNellis Partnersfor WOLF STREET:
The the wall street journal reported last week that April commercial property sales were down 16% from April 2021. Detailing the market’s loss of momentum, the paper said the hospitality, residential seniors, office buildings and industry were particularly hard hit, while retail and apartment building sales remained strong. The cause? Rising interest rates, inflation and economic uncertainty. The article ended with this hopeful quote: “It’s now turning into a buyer’s market.”
Maybe. But if a buyer’s market was universally recognized, sales volume would not have fallen from the 30th floor. Sellers and buyers would have been on the same page. Let’s say a hot seller’s market is in the height of summer, and a bone-seeking buyer’s market is in the height of winter. What we have today is this seasonal no man’s land, where the lingering summer heat chases away the growing cold for a day or two, only to be pushed back by the strengthening north wind.
In less poetic terms, we have a widening “bid-ask spread” i.e. sellers are sticking to their summer prices and cautious buyers are either scared off or looking for big winter discounts. This disconnection is at the origin of the dizzying fall in sales.
With the caveat that guessing national trends from personal anecdotes is indeed risky business, let’s boil down the Journal’s big numbers to the little ones. We listed a forty-unit apartment building in the East Bay in May, a few months too late. The bid date came with a single zombie offer, roughly 25% off the asking price. We refused.
Another offer remained pending a few days later. The buyer – a born negotiator – chiseled harder than Michelangelo, wore us down, and we finally agreed to a deal of around 7.5% on the list. Then a week into her 10-day “free look” this shopper dumped us with a text. No explanation, no complaints about the property, no other chasing – nada. Perplexed, we could only conclude that the buyer had become fearful and had decided to keep his money in his mattress.
Another failed deal: We listed a mall in the valley late last fall. He languished through the Christmas holidays. Then the wall bloomed throughout January and February. Then our broker announced news that was not news: interest rates had risen, anyone buying a Class B retail business was yield driven and we had to lower our price to maintain the yield of the property.
We lowered our price by 11% (a fair amount of money) and an offer finally appeared. Once again, Mount Rushmore chiseling rounds ensued, and we went into receivership. To get this center off our books, we even agreed to carry a first mortgage for three years, thinking we would eliminate the problem of reluctant lenders. Despite our willingness to cash in on the deal, the buyer walked away two weeks after their initial review without a word of complaint about the property or a desire for another price drop.
So our personal experience tells us that the Journal is on the money when it comes to downsizing, but note that both of our properties – commercial and residential – were among the subspecies expected to thrive nationally. (Back to the dangers of anecdotal evidence.)
But let’s get back to that shimmering mirage of a buyer’s market. We’ve been in commercial real estate for decades, and the only real buyer’s market we’ve ever known dates back to the early 90s, when the RTC took over the savings and loans business in bankruptcy and organized the biggest real estate sale since France. abandoned Louisiana. During this period, real estate ownership underwent a seismic shift: mom and pop investors and cowboy developers who owned overleveraged properties were wiped out. In their place came real money—institutional investors with pockets so deep they never had to sell out of economic necessity—owners who could ride out any market turbulence.
We’ve been looking forward to buyer’s markets before: the dot.com recession of 2001, the Great Recession of 2007, and the Covid recession of 2020. None ever materialized. At best, a handful of bargains have been selected at the margin. Opportunity funds – the billions of vulture capital that Wall Street has raised to snatch bargains at bargain prices – found themselves with an opportunity to pay top dollar for their acquisitions.
Real estate is not wheat, it is not a perishable good. In the absence of personal catastrophe, deep-pocketed sellers never have to sell. By John E. McNellis, author of Succeed in real estate: start as a developer.
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