by Neil A. Dolgin
The U.S. economy is seeing the highest growth in decades. But, inflation is also running at its highest level since the 1980’s. Both are outcomes of the pandemic, the unexpected halt and restart of the economy and the massive financial stimulus provided by the federal government.
“As cities eased lockdowns in the spring, the combination of pent-up spending, supply chain disruptions, wage increases, and higher energy and commodity prices prompted inflation to soar,” noted Commercial Search.
How inflation affects commercial real estate is the subject of daily conversations with our clients.
As inflation rises, property values and rental prices tend to rise. When rental rates increase while operating expenses are stable, building managers can realize an increase in net operating income.
However, when a rise in inflation combines with the increasing material, labor, and insurance costs, this causes a trifecta of problems for landlords who are going to watch every dollar because right across the board, the cost of managing a building has increased substantially. Renovations might be delayed. And rental rates for new tenants are likely to rise.
When demand for industrial space combines with a scarcity of industrial listings, prices for buildings and leases also tend to rise. That trends is starting to occur in the New York City metro-area.
For tenants the best hedge against inflation is to lock in a long term, 10-year commercial property lease agreement that includes a fair rental price combined with fixed and fair increases over the lease term, usually 3 or 4 per cent a year, depending on inflation. Landlords have the security of a long term tenant, and tenants have the security of fixed rental prices.
Inflation Challenges For Owners
When building managers try to squeeze higher rental prices from tenants, this is likely to cause tenants to leave the City for less expensive commercial buildings in New Jersey, Westchester, Long Island, and elsewhere, though prices have risen there too.
There is little inventory currently available, whether it’s New Jersey, Westchester or Long Island, and the best buildings have already been taken. So any efforts by landlords to squeeze the last dollar from a tenant as an inflation offset, is a challenge for businesses seeking to relocate here. We could see a mass exodus to locations with less expensive rents.
Real Estate Taxes
Commercial real estate taxes are increasing and not just by a small amount. They’ve increased a lot. And taxes may remain high adding to the financial challenges for building owners. The city faces severe financial challenges after the Covid pandemic and they need assistance. It’s unlikely that they’ll give building owners a break because they need the tax revenue.
Small Versus Large Industrial Spaces
How many more Amazon distribution locations will be established, how many more department stores or supermarkets are going to secure new industrial locations for distribution? We were just talking about an industrial property that has been on the market now for a couple of years, where the owners are asking ridiculously high rental prices based on what they paid for it. Lessors have showed little interest despite the repairs to the building, the cosmetic work, and fixes to everything that needed fixing.
Kalmon Dolgin is always looking to divide up large industrial buildings with one large unit and tenant into smaller units with multiple tenants. Why? If you lose one large tenant you’re at risk. If you lose a small tenant, they are replaceable. I see that as a big plus. That’s why Kalmon Dolgin has endured the pandemic and inflation challenges well. All our properties on Long Island and in Philadelphia are built around small tenancies. Management wise, it can be a headache, but financially, it makes a building more financially sound.
At some point, building owners still waiting for one large, major tenant to come in, should consider dividing up a building up into smaller units. Landlords can achieve this and save money by working with a third-party building manager like KND Management. We can help with every aspect of a building’s transformation. We know the cost of construction from building materials to labor. We can also bring higher efficiency to managing tenants, collecting rentals and making sure tenants are being charged the correct dollar amount. We have the infrastructure in place to manage buildings in ways that save owners money. We guarantee that we can save a substantial amount of money year over a year versus what an owner would achieve in managing a building.
Now is the Time To Act
Owners with an intention of selling should sell now as interest rates for buyers are continuing to rise. Real estate funds are still looking to purchase large industrial buildings though we’re seeing challenges to pricing based on higher costs of renovation work and the inability to secure the rental prices needed to build a cash positive business.
Owners with unoccupied large, industrial one- or two-tenant buildings should consider working with KND Management to reimagine your building with smaller, multi-tenanted units.
Companies that want to rent should act now by securing a long-term lease with fixed rent increases, to avoid higher rental prices later.
Have a question on inflation and commercial real estate? Email me any time.
Neil A. Dolgin is co-president of Kalmon Dolgin Affiliates. Founded in 1904, Kalmon Dolgin Affiliates (KDA) has grown into one of the New York metropolitan region’s leading commercial and industrial real estate firms. Kalmon Dolgin Affiliates specialize in all aspects of real estate services for developing, managing, selling, leasing and marketing commercial and industrial property. KDA’s highly-trained professional brokers offer clients a practical, street-wise approach to commercial and industrial real estate brokerage, leasing and sales, supported by the latest in real estate marketing, management and research technology.