In the wake of all that happened in 2020 and 2021, the new topic du jour is inflation. Is it inflation, or is it stagflation? It’s going to increase – no, it’s going to decrease. The Fed is going to…
Everyone involved in commercial real estate – for example, owners, tenants, brokers – looks at topics through their own lens: How is this impacting me? What will happen in the near future? What should I be doing about it?
To look at inflation from a point of view shared by all three groups, we sat down to talk with two of our leading brokers. George Macoubray is VP of Retail Brokerage, a longtime leader in the Portland retail property market. Gary Litvin is a Director, a seasoned broker with success in the vast Chicago market before coming to Portland. George deals primarily with landlords; Gary does mostly tenant work. So we talked to them both to get a balanced look at inflation’s impact on commercial real estate.
What are the main changes you’ve seen during the Covid era that led us to this point?
Gary: I work with tenants in markets all over the country, and I see the effects of inflation on different markets. The common denominator is that retail consumers’ behavior has changed since pre-Covid, and it’s been a serious challenge for businesses that don’t have a dominant product or deep pockets.
As far as recent changes, here are a couple examples. Gas prices have had a big impact in different markets, as people faced anything from $4 to $7 a gallon. That impacts how far they’re willing to go to buy something. For one sandwich shop I work with, their volume has increased considerably because people are staying closer to home and supporting more local businesses. However, with this, they’re also seeing customers from a smaller geographic radius. Another restaurant chain that has large footprints is seeing fewer large groups, but a lot more smaller ones. People gather in different ways than pre-Covid, and their choices are driven by factors like gas prices. This is one of the reasons we so closely study one and two-mile radius populations right now.
George: Yes, and it’s interesting that the Portland market is not slowing down. Despite rising prices and ongoing fears, it’s still a strong market with a growing population. People are coming out of their houses and spending money, so anyone who won’t go out, or go far, is replaced by new customers.
At the same time, the cycle of supply chain problems, labor shortages and increased wages has slowed everything down, even in a growing market.
How would you describe the current economic picture in commercial real estate?
George: It’s straightforward: Almost everything costs more, and takes longer. A retail shell that previously cost $40 a square foot to build now costs $75-$80. Same for existing facilities – building out a space costs almost double what we’re used to.
Gary: Landlords were desperate for tenants as recently as six months ago; now they’re raising rents to keep up with their own costs. Rents have returned to pre-Covid levels, or even higher. Cost and access are both a challenge for tenants: Let’s say you find a space at a rent you can afford; if you need a buildout, you don’t know how much it will cost or how long it will take to get contractors and materials.
So how are tenants and landlords reacting?
Gary: Retailers are having to raise prices, because rents and other costs are going up. Landlords have to recover their own increased costs for construction and materials. The businesses that are surviving are those that have a strong reputation, or a product so good that people don’t mind paying more.
George: Landlords are both sharpening their pencils and resetting their expectations for returns. Construction hasn’t really paused, but the developers are making less and being more selective about where they build.
Gary: Tenants have pretty much accepted the higher cost of doing business, and consumers are getting used to the new prices – if it happens long enough, it just becomes the new reality and everyone adjusts.
George: High-quality projects with solid clients in good trade areas are still going strong. Established tenants like national chains with a strong concept and ample resources have an advantage. That said, NAI Elliott works closely with developers to include locally grown businesses; the retail center should reflect the neighborhood as much as possible.
Acknowledging that you’re not economists, what do you think lies ahead?
Gary: You have to factor in that we had historically low inflation for years, pre-Covid. We were ripe for this kind of rise in costs and prices; it took Covid to make it happen. And although inflation seems to be slowing down, things are not going back down to what they were.
George: I agree. I don’t think it’s going to keep going up drastically; I think it’s leveling off.
What advice are you giving to your clients, for adjusting to today’s market and having a good strategy going forward?
George: Be really cautious as you budget any project, whether it’s new construction or a buildout in existing space – costs may have gone up more than you think. And make sure you’re using reliable consultants and contractors, because you’re all going to have make adjustments on the fly.
Gary: There’s a tension between tenants and landlords over timing: Do you commit to a lease, not knowing when the space will be finished? Facing rising rents and costs, tenants need to be both cautious and creative. For example, ask the landlord for mutual flexibility on timelines. As far as trying to retain customers and survive, consider making some adjustments to your business model, and see what happens. I had a restaurant client cut their evening hours, and they didn’t see a drop in total sales. If you have a good product and reputation, your customers will adjust to changes. It’s what we’ve all been doing for two years now!
Just as consumers are having to accept higher retail prices, commercial tenants are also learning how to adjust their rent and timing expectations while landlords continue to face increased material cost, delayed schedules and possibly smaller margins. Ultimately, both George and Gary are seeing the same thing, and we concur: the market has changed, in all likelihood permanently, so while no one is loving it, we are all dealing with it.