The Bid-Ask Price Gap Ignores Pandemic's Upheaval

To hear the listing team describe it, 1372 South California Blvd., in downtown Walnut Creek, CA, is the perfect investment property. It is a 25,520-square-foot two-tenant retail property anchored by a strong performing Trader Joe’s and Pet Food Express backed by CVS credit. Sansome Pacific Properties was the seller, represented by Putnam Daily, Lindsey Snider, and Michael Maffia with Preserve West Capital.

“There is an incredible amount of demand for well-located, high-quality net lease retail investments anchored by high-volume grocery tenants like Trader Joe’s,” Daily said at the time of the sale. “With limited supply of opportunities in this space, especially those with long-term development potential, we experienced as much inquiry and interest as we have had for an opportunity in the last decade.”

After receiving multiple offers the first week of marketing, Sansome Pacific Properties selected Loja Real Estate, which paid the full asking price for the property.

An Ongoing Tug-of-War

Sansome Pacific’s sale is just one data point, but a telling one.

Buyers and sellers of commercial real estate properties entered the pandemic with their usual gap in expectations of pricing—and then refused to move closer to each other despite the upheaval in the markets. To be sure, there were scarcely any transactions at the start of the pandemic to judge whether sellers were willing to come down in price. But as the pandemic wore on and the markets began to move again, it became clear that sellers were not willing to bend. Now, with the CRE markets in recovery, it appears that they are doubling down on that position.

Much of this is due to the demand for certain assets. Buyers have most aggressively focused on properties that weathered the pandemic best, namely those in the industrial, multifamily and self-storage sectors. Investors have also targeted property types expected to make a quick post-crisis recovery, such as hotels as well as certain types of retail and seniors housing, according to a Marcus & Millichap report. “While some discounting has occurred in unique situations, valuations of most asset types have largely held steady or surpassed pre-health crisis levels as strong buyer interest has aligned with limited for-sale inventory,” the report says. “This dynamic has also led to cap rate compression among sought after assets.”

Changing Dynamics

There are signs, though, that sellers don’t hold all the pricing power. Commercial real estate price growth as measured by the RCA Commercial Property Price Index is expected to remain below 2020’s 5.2% for the next three years, dropping to 4.2% in 2021 and increasing to 5% in 2022 and 5% in 2023. At the same time, commercial real estate transaction volume is expected to recover relatively quickly through 2023, to $590 billion versus $500 billion in 2021, according to the Urban Land Institute. Last year, volume fell by almost 30% in 2020 to $427 billion from a post-Great Financial Crisis peak in 2019 of $598 billion.

Pricing will also be affected by rent growth, which is expected to vary depending on the asset type but generally continue to improve over the next few years. ULI predicts that this year industrial and apartment rent growth will be 4% and 1.7%, respectively, while retail and office are forecast at -2%, and -2.9%, respectively.

There is also the wild card of the Biden Administration’s multiple tax proposals that could affect commercial real estate. While these have yet to go through what is sure to be an arduous lobbying and negotiating process, some experts are predicting that more investors might be inclined to sell before these proposals become law.

For instance, the administration has proposed raising the capital gains tax of 20% to 39.6% for households reporting income over $1 million. However, Bitner predicts that this tax increase will eventually land at 28%. Cushman & Wakefield’s David Bitner, global head of capital markets research insights, thinks investors will have some incentive to sell before these changes occur, though he believes it’s likely that the change will happen in the 2022 tax year. In a report, he speculates that these changes may make a sale more attractive to investors already considering dispositions. In addition, long-term holders with gains not yet realized may also consider selling if they do not believe market conditions are distinctly unfavorable.

The administration’s proposal to eliminate like-kind exchanges for gains exceeding $500,000 could also keep buyers out of the market, says founder and president of ResMan Elizabeth Francisco. “Like-kind exchange rules encourage investors to remain invested in real estate. Prior to taking ResMan to market we managed 1031 Exchanges. Within our portfolio, we had several assets that were purchased from a new construction developer who took the proceeds from the sales to fund development of new apartment communities.”

Still, one should not discount the stubbornness of sellers even in the worst of a market. Last year, the chasm between commercial property buyers and sellers not only remained in place but actually widened in the third quarter, putting a strain on sales, according to CBRE.

It reported that while 61% of buyers expected discounts from pre-pandemic prices, just 9% of sellers were willing to offer such price breaks, the research said. New criteria from purchasers didn’t help. CBRE found that investors were placing greater importance on tenant credit quality, which was cited by 85% of respondents, and both length of remaining lease term and building occupancy—which each came in at 64% of respondents—than they did prior to the pandemic.

A Market By Market Story

All that said, each transaction has specific factors that can favor a buyer or a seller, despite the wider market trends. Retail properties are not necessarily high on investors’ wish lists right now, for example, but as Sansome Pacific Properties showed, certain assets can be hotly pursued even in this market.

“It depends on your location and product type,” Edward Easton, chairman of the Easton Group, says.

“Up until now, there was a big gap. Properties weren’t trading that often,” he says. But some areas have shaken loose in his home area. “In the industrial market in Miami, the bids and asks are not far apart, and the buyers are bidding up,” Easton adds. “It is kind of the case in rental housing, also. I don’t think that’s the case in retail.”

“In our world, the bid ask spread has shrunk over the last six to 12 months,” John Feeney, senior vice president of the Boulder Group, which focuses on the single commercial tenant space, adds. But even as some things loosen up, others haven’t.

Casual dining, fitness gyms, movie theaters, and other such establishments took the pandemic on the chin and went down for the count. Investors didn’t want to touch them, “particularly retail and hospitality but also in office and multifamily,” Lisa Knee, a partner at accounting, tax, and advisory firm EisnerAmper, says.

“With so much equity capital available for real estate investment there is tremendous competition for deals,” Knee says.

For Boulder Group, the popular properties have been pharmacies, grocery stores, and other essential businesses. The result was less overall supply, creating what looked to be healthy demand. That drove the bid-ask split up.

“I’ve lost options, so there are going to be other people doing the same thing,” Feeney says of buyers’ reality.

In the Southeast, even land has seen high ask prices, according to Hunter Suggs, director of South Carolina commercial real estate for National Land Realty.

“The run up in land prices over the last nine to 12 months in the Southeast can be primarily attributed to the increase in demand from single family developers and builders, along with multifamily developers, for those quality sites checking the right boxes,” he says. “The implications for the spike in land pricing are sellers with elevated expectations, but in tandem, we are seeing a certain percentage of the developers/builders with a willingness to pay the premium pricing for the best land positions.”

But while many property owners have held out for the price they want, many may have to soon give the strategy up.

“The bad news is that over $400 billion of commercial and multifamily debt matures this year,” says Marina Vaamonde, an investor and founder of PropertyCashin.com. “Government stimulus can’t last forever. Release of 2020 Census data shows increasing flight from major metropolitan areas, and increased inflation is expected by many economists.”