I don’t believe in market bifurcation regardless of location or property type. I believe it’s all connected – some more directly than others. The house in Rancho Santa Fe cannot stabilize at $3+mil if a comparable house in Fairbanks stabilizes at $1.5mil, and the Fairbanks home can’t stabilize at $1.5mil if the Carmel Valley home ends up at $800k. And so on. Eventually, you can connnect the dots between the beater properties in Barrio Logan and the mansions in La Jolla because there are always alternatives. Premiums (and discounts) are based primarily on advantages (or disadvantages), and over time they’re always proportional.
If a Class A office building can’t get $3/SqFt in rents (under Gross terms) then how can it justify a sale price in excess of $400/SqFt? Over the long haul I don’t think it can. Sooner or later the mortgage interest rates will come up, and cap rates will have to come up with them. We’ve seen cap rates that are lower than mortgage interest rates – there’s no way that’s sustainable unless pricing continues to INCREASE (and stabilization isn’t increase). The most agressive investors don’t buy to hold – they buy to flip; and the ones who do buy to hold are not as agressive.
Just like with the housing market, once there’s no short term upside the hyper agressive investors will split and cap rates have to adjust up. As I’m sure you’re aware, between rent concessions, increased vacancy rates and increased cap rates, a commercial building’s income potential, and hence its value can decline pretty quickly.
Over the long term, I think there are some Class A tenants who would be willing to move to Class B space if the rent differential made it worth their while. And likewise as we move down the chain and outward in location. That’s why I think an office or retail or industrial meltdown in the outlying areas will eventually make its presence felt in the more centralized areas.
The only question is whether the trends will hold long enough for that to occur. Reasonable people will disagree on that one, but I think the trend will definitely continue.
