How entrepreneurs are playing the commercial real estate market.
The commercial real estate market must feel lonely these days -- its cousin, the housing market, is getting all the attention. But commercial property prices are softening, too, which is good news for entrepreneurs looking to buy real estate or sign a new lease. Vacancy rates have been rising since late 2007, a positive sign for renters. Most banks have tightened their credit requirements, so there are fewer buyers in the market. And real estate investors are sitting on the sidelines, waiting to see how prices play out. "Last year, if you had an empty building, you had 10 people bidding on it," says Al Mirin, a senior vice president at CB Richard Ellis, the international real estate brokerage. "Now, you have three or four."
That means this may be a good time for business owners to scout for new locations -- or make that long-awaited purchase. Dallas entrepreneur Lars Hundley, for example, had always planned to buy a warehouse for his business, Clean Air Gardening, an online retailer of gardening equipment. The weakening real estate market allowed him to do it sooner. Ever since founding the company in 1998, Hundley had outsourced the packaging and shipping of orders. By 2007, however, the cost for that service had ballooned to more than $10,000 a month, sometimes as much as $20,000.
So when the real estate market in Dallas began to cool, Hundley decided it was time to bring shipping in-house. Last spring, he put 20 percent down on a $635,000 warehouse and hired two more employees to handle orders. The seller was in a hurry to unload the property. A previous offer had been accepted but had fallen through when the buyer couldn't find financing, and Hundley was able to pick it up for about 5 percent less than its asking price -- not a steal, but a good deal nonetheless. Even after the cost of insurance, taxes, and the $6,600 monthly mortgage payment, Hundley says the company will save almost $50,000 a year. Plus, he has a real estate play. "Before, I had a domain name and inventory, but that's about it," Hundley says. "Owning a building gives me a hard asset that I can pay off and eventually sell or rent out to someone when I retire."
Don't expect to find fire-sale prices -- at least not yet. Purchase prices peaked last year and have fallen since then, according to real estate data firm Reis, but this is nothing like the downturn of the late 1980s and early 1990s, when real estate in some markets was dirt-cheap. In the first quarter of 2008, the average purchase price for office space was $247 per square foot. That's a 9 percent decline from the previous quarter, when the average price was $274. But compared with the first quarter of 2007, prices are basically flat. "Fundamentals aren't terrible right now, but they're starting to show signs of weakness," says Chris Stanley, an analyst at Reis. That means the market could decline further. According to a report from Goldman Sachs, commercial real estate prices nationwide could fall 25 percent by the end of 2009, compared with their 2007 peak.
Rents are also softening, even in areas that have seen nothing but growth in recent years. In southwest Florida, rents grew only 3 percent from the first quarter of 2007 to the first quarter of 2008, compared with 19 percent from 2006 to 2007, according to real estate data firm CoStar. In Austin, growth has slowed to 5 percent, down from 19 percent. And in Orange County, California, prices were flat, compared with a 12 percent increase a year ago. But Mitch Roschelle, head of the real estate advisory practice at PricewaterhouseCoopers, says it's hard to predict whether they will continue to fall. "There's a fair amount of wait-and-see going on," says Roschelle, who believes landlords and tenants may opt for short-term leases so they don't get locked into prices they will later regret.
If you're interested in buying but not ready to take the plunge, you have another option: Ask for a lease with an option to buy after one or two years. When a property has sat on the market for a while, sellers are more willing to consider this option, says Brian Burke, a real estate developer in Costa Mesa, California. There are a couple of drawbacks. Landlords generally won't make a lot of changes to the building; instead, any renovations are done at the tenant's expense. And you may have to pay slightly higher rent, Burke says, though a portion can sometimes be credited toward the purchase price.
Buying space isn't an option for Larry Kutscher, CEO of Register.com -- his company, which has 400 employees, is based in midtown Manhattan. But he hopes he can take advantage of the relatively tepid market to find a good deal on a new lease when his current one expires in September 2009. Even in New York, which remains one of the nation's strongest commercial real estate markets, rents have been rising more slowly amid the problems in the financial services industry. Kutscher has already hired a broker to scout new space, and he has had some friendly discussions with his current landlords. He thinks the market will slow further, so he is not in any rush. "Time is our friend right now," says Kutscher. "We are hoping the change in the market will make landlords more reasonable with their expectations."
Kutscher is also something of a lease vulture. He is keeping an eye out for space left vacant by downsizing financial services firms; he hopes that another company's misfortune might be his good luck. "We are hoping that space opens up and we can get something nice for less," he says.
Inc. Readers Weigh In
Inc. surveyed more than 300 entrepreneurs about the real estate market. Here's what they said:
Do you think the real estate market could affect the valuation of your business?
12% Not sure
Are you considering buying property for your business because of the weakening real estate market?
12% Not sure
Want to know what's happening in your city? We put more data from CoStar online. You can find price information for the retail, industrial, and office sectors in more than 60 markets at www.inc.com/keyword/jul08.