The commercial real estate sector in Orange County operates within a dynamic environment where market conditions, particularly interest rates, are in a constant state of redefinition, according to Allen C. Buchanan, SIOR, a principal with Lee & Associates Commercial Real Estate Services in Orange. Buchanan emphasizes that what one generation considers 'normal' can be vastly different from another's experience.
Historically, interest rates have shown significant swings. Buchanan, who began his career in 1984, recalls a period when the bank prime rate averaged over 12% and briefly reached 13%. At that time, the prospect of borrowing money at 8% seemed highly optimistic. However, by 1986, the prime rate had fallen below 8%. It later climbed to 11.5% in 1989 before descending again, reaching 6% by 1992. By the late 1990s, rates around 8% were considered ordinary, with the Federal Reserve's historical data showing prime averaging 8.35% in 1998.
The definition of normal shifted dramatically following the financial crisis, ushering in an era of exceptionally inexpensive money. The federal funds rate remained near zero for an extended period and returned to that level during the pandemic. In 2021, the effective federal funds rate averaged a microscopic 0.08%. This created a distinct learning environment for those entering commercial real estate, contrasting sharply with the double-digit interest rates experienced by earlier professionals.
Buchanan points out that the cyclical nature of commercial real estate extends beyond interest rates to other market fundamentals. Following the Great Recession, for example, a surplus of available buildings provided occupants with significant negotiating leverage. As the economy improved and e-commerce expanded, vacancy rates steadily declined, leading to scarce availability, escalating rents, and increased leverage for landlords. This period also felt like a new normal, driven by an extraordinary demand for warehouse and distribution space, until conditions shifted once more.
Property values mirrored these trends. When borrowing costs were low, investors could justify higher purchase prices while still achieving acceptable returns. This led to an influx of capital into industrial real estate, compressing capitalization rates and driving property values upward. Owners grew accustomed to aggressive pricing, and buyers relied on financing that made such prices feasible.
However, this environment changed significantly starting in March 2022. The Federal Reserve initiated one of its most rapid tightening cycles in decades, elevating its target rate from near zero to more than 5% by summer 2023. This rapid increase has led to higher debt costs, challenging refinancing scenarios, and the necessity to recalculate investment returns. Transactions that were viable just two years prior no longer 'penciled out,' according to Buchanan.
In light of these continuous shifts, Buchanan advises commercial real estate owners and occupants in Orange County to move beyond asking, "When will the market get back to normal?" Instead, he suggests focusing on, "What do today’s conditions allow me to do?" This perspective highlights current opportunities:
For owners, elevated borrowing costs and fewer competing buyers may create avenues to acquire buildings that previously would have attracted numerous offers. For occupants, increased availability could provide more choices and negotiating power absent during periods of high demand. For sellers, a limited supply of quality owner-user buildings may still present an attractive exit strategy. For companies facing lease expirations, the current environment might favor an early renewal, relocation, or even a purchase, depending on specific circumstances.
Buchanan concludes that waiting for a "mythical set of conditions we call 'normal'" is counterproductive. His decades in commercial real estate have shown him periods of double-digit interest rates, cheap money, recessions, recoveries, tight vacancy, abundant vacancy, rapidly rising and falling rents, lending crises, and intense investor interest. Each condition felt permanent at the time. Commercial real estate markets are defined by constant movement, capital adjustments, supply responses, demand changes, and the migration of opportunities between sellers and buyers, landlords and tenants. The ongoing task, he states, is to understand the prevailing market and make the best decisions it permits.
