Never Forget That Not All Commercial Real Estate Is Office
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A current read of the nation’s business press brings a sense that the entire commercial real estate space has entered a doom loop from which there is no escape.  But that would be a misguided – and potentially costly – assessment for investors.

The gloom is reinforced by the unending stream of accounts of commercial space being unloaded for a fraction of what was considered premium pricing a short five years ago. Now, colleges and universities are using this dip to snap up Class A office space in transactions that would have previously been unlikely. Few could have predicted sponsors walking away from prized projects or top markets as demand for office space cratered. Many large companies seem resigned to remote or hybrid work being the new norm, which will sustain high office vacancies in the near term.

Many investors see merit in being contrarian, but the reality is that too many investors only have “contrarian courage” when everyone else does, too. Lenders seem to have the greatest difficulty in shaking the group mindset, so they’re unlikely to play along with aggressive bets.

Since those equations won’t work too well right now, it might be time to toss the “conventional contrarian” wisdom aside and just invest in businesses that will thrive long-term based on proven fundamentals. 

Several commercial real estate sub-sectors remain vibrant and investment-worthy in both the short- and long-term. The factors that make them attractive are the flip side of what makes office buildings currently problematic: Overall demand trends, cultural, societal and demographic trends, technological trends, capital availability, and prospective returns.

  • Data centers - The explosion of artificial intelligence and the complete societal technological transformation it’s bringing with it means demand for data centers is enormous, with consulting firm McKinsey & Company seeing 10% annual data center growth. Investment vehicles in the space include pure-play publicly traded data center companies including data center REITs, large companies like Amazon and Google that have huge data center arms, and private equity funds. This sector does not lend itself to bootstrap entrepreneurs due to its capital intensiveness, creating a barrier to entry.
  • Warehouse & distribution facilities - The move to e-commerce, which is now receiving an assist from stories of growing urban retail closures and threats to public safety, has been an inexorable 20-year trend and isn’t abating. Giants like Blackstone have already made great returns in the space, but demand keeps growing. Vehicles include industrial REITs, private equity, and with a bigger checkbook, and stand-alone direct user investing. 
  • Mobile home parks - High interest rates are making housing affordability an enormous issue for Americans, and mobile home parks offer some partial relief. High levels of immigration may also fuel the short and intermediate-term demand for lower-cost housing. Mobile/manufactured housing parks have attracted large inflows of capital in recent years and demographic and economic trends remain powerfully in the sector’s favor. Similar to other sectors, there are dedicated manufactured housing park REITs, limited partnerships, and direct investment possibilities. There’s definitely an opportunity here for a range of institutional, as well as smaller scale investments.
  • Self-storage facilities - Full disclosure: I run a growing self-storage company, so I’m biased, but I do put my money where my mouth is. Self-storage demand continues to grow, recently fueled by post-pandemic lifestyle changes (creating office space at home for permanent semi-remote jobs) and relocating valuables to allow for it. High interest rates are preventing people from getting the bigger homes they might like to right now, and high out-migration from high-tax jurisdictions continues. For investors, high-profile REITS such as Public Storage emerge as the most visible operators in the space. The industry is still full of mom and pop enterprises though, indicating vast potential for an enterprising investor. According to data compiled by Statista, the self-storage market is projected to be worth $65 billion by 2026, up from $48 billion in 2020. In recent years, vacancy rates have held steady between 8-9% industry-wide - with the notable exception of 2021 when they dropped below 7% - not the only time self storage has thrived when other real estate suffered. The number of self-storage outlets has doubled over the past 25 years from about 20,000 to 25,000 to in excess of 50,000 now - not bad for an industry that’s only about 50 years old. 

As for the office sector itself, a contrarian bet on it might be advisable, but I don’t think it offers a durable long term business plan as much as a short term trade. Right now the environment and sentiment for office buildings remains unfavorable and future demand prospects remain uncertain. That makes it less likely that this is the moment for smaller investors to jump in. 

So, yes the coverage of “commercial real estate” is unduly focused on the office sector, and that tunnel vision can make it look like investment opportunities are limited. The rapid anti-inflationary interest rate increases may be about to level off, but rates don’t look to be moving down anytime soon, putting overall pressure on every category of real estate. 

Meantime, compelling niches in commercial real estate remain and represent powerful generators of wealth with moderate risk for investors. The key remains understanding underlying factors relating to the specific economic drivers that impact niche sectors with great opportunities.  Find a sector with strong fundamentals, an excellent location, plus long term prospects for growth and increasing rents and profitability will follow.  


Noah Mehrkam is the CEO and Founder of Self Storage Plus. 

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