The ‘new normal’: Those who can’t adapt will be forced to transition

Bill Norton

We are at the end of May and the commercial sector is booming, only retail and offices are lagging behind. The Fed announced a 50 basis point hike yesterday (and more to come). The inflation genie is out of the bottle and you’re still guessing how to put it back! In this case, it has been a long time since we had to deal with significant inflation. The general strategy is to squeeze, squeeze, squeeze until prices come back down. However, after such a long time with little or no inflation, prices this time around will not come down completely. The $24 ½” plywood sheet, which is now $60-$70 (if you can find it), will end up around $40-$50. Eggs that used to cost $1.39 a dozen and now cost more than $3 will end up between $2 and $2.50. The minimum wage will effectively be $15 an hour with increased deductions (Social Security, Workers Compensation, SUTA, FUTA….).

With the large number of cash buyers (commercial and residential), high prices will remain a bit high, even with rising interest rates. With residential mortgages in the 5s and rising, and second homes in the 6s trending at 7%, many “potential” buyers will pull out. But with demand still well above supply, it could be a while before we see sales drop and prices drop significantly. One outcome is that the first $400,000 home will go for $350,000, the $700,000 condo will go for $600,000…

The rise in real estate prices has been accompanied by an increase in taxes and a sharp increase in assessments. Property tax revenues hit a record high in 2021 (over $327 billion). At the same time, utility and energy costs are rising. I look around my neighborhood and wonder if some of my new, younger neighbors have gone too far? Only time will tell.

Commercially, the high cost of new construction makes existing inventory look like a bargain. Even simple fittings and refreshes (carpeting and painting) have doubled in cost. When paired with tenants wanting a shorter lease term as they battle the pandemic, work from home, return to the office and perhaps a “hybrid” model, it suggests rising rents, but with low demand and excess space, the market does not support this. Owners are happy to get cost increases to cover higher taxes and utilities.

I read recently (somewhere) that 87% of surveyed employers want to return to the office full time while only 10-12% of employees want it. I guess the end result will be somewhere in the middle. Remote work is not an issue for around 30% of the workforce. Some even increase their productivity by working from home. An additional 30% may do so voluntarily or reluctantly, but with certain distractions (kids at home, homeschooling, distance learning…), effectiveness decreases. The other 30% probably aren’t as productive, and over time, that’s where the “new normal” will take a bite out of. Those who cannot adapt will be forced to transition.

The hybrid concept sounds simple, but in most cases it doesn’t result in a significant drop in space or occupancy costs. A company on our floor requires employees to be present on Tuesdays, Wednesdays and Thursdays. with Monday and Friday optional. Another allows for flexibility, leaving the choice up to the employee but requiring at least two days in the office. Eventually the demand for office space will decline for a while, but I guess we Homo sapiens are social beings and will eventually come back to the office, maybe at 75-80% of the time. previous standard.

Meanwhile, demand for high-rise, warehouse/distribution abounds. Alas, the cost of building this space has jumped (here in New England at $150 per s/f – $160 per s/f). On a recent road trip down I-95 in Florida, I was struck by the fact that Amazon and others were setting up millions of square feet of mega-distribution centers, in Sunbelt malls are under construction or expansion. It looks like a conflict. But perhaps with the ongoing migration to the Sunbelt, both can survive and thrive.

At the moment we are very busy, but we suspect that with rising interest rates things will slow down by the end of the year. How much remains to be seen. As a practitioner for over 40 years, I often say that we make money in a rising market and a falling market. We have had over 20 years of a rising market (with a few bumps). But the next 12 to 18 months will be interesting.

Bill Norton, CRE, FMA, Hon. AIA NH, is Chairman of Norton Asset Management, Inc., Manchester, NH.

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