Thursday, May 26, 2022 May 26, 2022
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Commercial Real Estate

CRE Opinion: Musings from the Press Box at the Top of the Ninth

Water inefficiencies, overbuilding, and geopolitical events that could cause a correction in this long running cycle.
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Robert Grunnah, Younger Partners

As we continue through the longest economic recovery period in recent history, most indicators remain level promoting a perceived stability. There appears to be no common agreement on the remaining length of this positive cycle being offered from knowledgeable prognosticators. Most feel a predictable “correction” is inevitable and most seem to be wisely preparing for it.  Industrial, multifamily, Class A office, and hotel construction continues at a record pace, although all are beginning to display moderate discipline with significant decreases in new and planned projects. Stealing a comment from Wayne Swearingen, “Are we really overbuilt, or just over announced?” Earlier periods in similar cycles resulted in major corrections that required severe financial adjustments. Retail construction, perhaps the only slow growth segment, has shown its vulnerability to the obvious internet invader that has a growing, competitive edge.

Active single family growth continues, despite highly inflated costs of materials, labor, and record high undeveloped raw land prices. The gap between existing home prices and new home supply continues to increase despite the 40 percent price increase in home values over the past four years. For all segments to continue to benefit, elevated concentration on the construction of adequate infrastructure facilities is critical. Perhaps the largest threat to continued growth is the inadequate water supply. While precipitation in 2017 was at near record highs, a summer like 2016 would exhaust our deliverable supply with just the past year’s new construction. New reservoirs require decades of planning, approvals, and construction. Water is rapidly becoming our Achilles heel.

In comparing our company’s current brokerage activity and product focus with that of just five years ago, we see little activity in severely overpriced income producing acquisitions. Sale prices are two and three times replacement cost, even with land and construction costs at record highs. Scrambling for yields has made this investment vehicle extremely vulnerable in all vertical asset classes. Their susceptibility to a negative national economy spells long-term failure to some and severe stress to most. Specialty products, self-storage, hotels, student housing, and certain medical uses are rapidly being overbuilt. Single-family development will continue profitably for the forward-thinking developer even though development costs demand a reasonably low raw land cost. While occurring much later in a positive cycle than seen in the past, investment land have seen significant increased activity over the last year. This is perhaps one of the last real opportunities if one can believe the enormous long-term growth projections for our region. Even in view of our pricing surge over the last few years, DFW remains one of the most logically attractive areas for conservative real estate investment.

Immigration, climate change, a far above average number of natural disasters, a national economy correction, political discord, Ezekiel Elliot, and Kim Jong Un are all but a few of the disruptive influences that, while not directed specifically at real estate, can artificially have dramatic affects, all not necessarily negative. It appears to me that our American society seems much more sensitive today, perhaps overly so, to social and political events. Who would have expected a kneeling incident to cause a national social uprising sufficient to threaten one of America’s most treasured pastimes?  DFW is a resilient community that has historically successfully confronted adversity and challenge on many levels. We have amongst us a group of the most intelligent, creative, visionary developers, architects, engineers, financiers, and entrepreneurs with the energy and resources to successfully confront the issues and support the anticipated growth. While there will always be bumps, experience and discipline will endure (maybe).

Robert Grunnah is a Member of Younger Partners.

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