Where is the Demand?

I began my career in the CRE industry in 1981. I left the public accounting industry to be Controller and then Assistant Vice President of Acquisitions for a high growth real estate syndication company headquartered in Chicago, IL. As a young real estate accountant/analyst, I was responsible for preparing 10-year proformas of all types of CRE deals on long column paper (as computers were just being introduced back then). Some of the deals had dozens of tenants, which were included in the gross potential rent line by tenant. I was also responsible for attending and closing the real estate acquisitions for all property types and all over the country.

One of my mentors at this time was a more senior person named Mike and he taught me to always ask on any real estate property, “Where is the Demand?” This means; where will the demand or tenants come from to lease the property and generate the gross potential rent, whether it be a retail center, office building, industrial property, apartment complex or hotel. Each of these property types, based on location, physical construction, amenities, rent level, lease type, market and management, will have high, medium or low attractiveness for potential tenants. This demand factor is critical to generate the gross income and maintain or create value in any piece of CRE. There can be two identical properties on the same corner, and they may be valued differently based on these demand factors. The most successful CRE investors know what demand factors are key to their property and exploit them to maintain high occupancy and cash flow.

One of the key problems CRE investors make in an acquisition is not knowing where the demand for the property will come from. This has been especially true in the last few years in the retail industry. Many investors that bought malls and open-air shopping centers during the last five years were oblivious to this demand issue. They assumed that since the property was historically 98% leased, it will always stay that way. However, as many of us have seen, the brick and mortar retail industry has been in upheaval due to competition from the Internet, changing shopping habits and the over-abundance of retail space around the country. This has led to thousands of store closings and bankruptcy of dozens of once-solid retailers like Sears/Kmart, Toys R Us, Gymboree, RadioShack, Payless, Forever 21 and many others. The apartment market was very strong until about eighteen months ago when rising rents began to plateau and free rent has appeared in some markets. This was due to the record construction of more than two million new units built in the last five years. Some states including Oregon, California and New York have initiated rent control laws and this will be followed by many more. These anti-market rent policies will affect the income of a property and in five years or so there will be a two-tier apartment market in the U.S. The top and most attractive tier will be states that pursue market policies with no rent control and the bottom tier and least attractive market will be the above states and others with anti-market rent control policies. National apartment investors also have to ask the question of where the demand or tenants will come from for apartment investment in some of these markets. Again, analyzing the demand side of multifamily will be key to success in the future.

The hottest sector of CRE today is the industrial market. Industrial properties have flourished due to the booming economy, artificially low-interest rates and demand from e-commerce delivery, especially same-day home delivery. Owners of industrial properties have benefited from higher rents with the average net rent up from about $6 per square foot to about $7.25 per square foot. Also, industrial cap rates have compressed from an average of about 7.5% to about 6.0%. While industrial is doing well today, what happens when the next recession occurs and demand drops. Again, investors need to ask; “where is the demand?”

All real estate investors and owners today have to know where the demand will come from for their property, whether the property is 100% or 50% leased. In today’s changing market, this demand is being significantly affected by technology and data analytics. The proliferation of software, artificial intelligence, big data, Internet sales, mobile payment systems, cashless stores and other information technology applications, has affected the demand for CRE and owners must be cognizant of these techno trends to make sure of the demand side of the property.

Joseph J. Ori is executive managing director of Paramount Capital Corp. The views expressed here are the author’s own and not that of ALM Real Estate Media Group.