Good morning. It's Sunday, October 4, and in this week's edition, we're covering why big-deal property prices keep sliding while smaller deals sit near a record high, a cooler inflation print that barely moved a 10-year near its highest since 2007, and the asset everyone says is dead that we just put under contract.
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Commercial property prices split in two in August. Prices on big deals fell 1.3%, their fifth straight monthly drop, and sit 19.4% below the July 2022 peak. Prices on smaller deals rose 1.4% and sit 0.5% below their record, set in March. Large assets in major markets are still repricing. Smaller assets in secondary and tertiary markets are holding. Providence Place Mall shows the gap. In 2004, it traded for $510 million, about $365 a foot. Last month, it sold for $133 million, about $95 a foot. Industrial went the other way - 391 repeat sales gained about $826 million over their prior prices. This landed as the Fed raised rates for the first time since 2023.
"How to add value to your property": Ben Mallah tours a 180-plus unit apartment building his team bought two months ago, walking the rehab in progress - new vanities, a cabinet design that blocks the hot water, and a debate over paint where he pushes for oil-based on the cabinets. His standard for every unit: finish it like you are moving in. A real look at contractor oversight on a value-add deal. Watch here
"The Best Property to Buy in 2026 (For Beginners)": Graham Storey makes the case for small industrial - 5,000 to 20,000 square foot buildings leased to contractors, trades, and e-commerce businesses. His three reasons: simple buildings without expensive buildouts, strong small-space demand while new construction goes big, and multi-year leases. Then he breaks down a $580,000 deal he recently bought, targeting about $2,500 a month net once the new lease is in. Watch here
Inflation came in cooler than expected, and the 10-year barely noticed. The PCE price index, the Fed's preferred inflation gauge, ran 3.4% year over year in August against a 3.7% forecast. Traders cut the odds of an October rate hike to about 35%, down from 45%. Second-quarter GDP showed solid growth, driven by consumer spending and AI infrastructure investment. ADP reported 90,000 private-sector jobs added in September, up from 36,000 in August. The 10-year Treasury held at 5.25%, one day after hitting its highest level since June 2007.
CRE Impact: A softer inflation print may keep the Fed on hold in October, but most fixed-rate commercial loans are set off the 10-year, not the Fed. Until that number comes down, underwrite your deals and refinances at today's borrowing costs.
I mentioned in an earlier issue that from time to time, the Deep Dive will be a deal we're working. This is one of those weeks.
This week we put an office and flex complex under contract, which is way more office than we would normally buy. It's 80% office and 20% flex, about 350K square feet, one story, with about 50% medical use.
We're buying at a really attractive basis, below $50 a foot, at an in-place cap rate in the double digits, with a little less than a quarter of the buildings vacant. One of our partners was chasing this deal for four years, and we finally got it. Looking at the numbers, it's looking like one of those banger deals that comes once every 5-10 years. But it takes courage to see where the value can be created when the notion on the street is that office is dead, and AI and work from home killed it.
So here is what I'm seeing from due diligence and keeping a close pulse on this asset. Leasing velocity is definitely alive, and businesses are looking for space to lease. I'm seeing this looking at deals in one-story office. I'm also seeing that spaces under 2,000 square feet move fairly quickly. Larger spaces, 5K and up, lease up much slower. Another big issue with larger spaces is that they require complete reconfiguration, and pretty often a rebuild from scratch, where TIs of $40-$50 a foot or more are common.
The next surprise in office is that leasing commissions, at least in Chicagoland, use a completely different methodology. If you have two brokers on a lease deal, it averages $1.75-$2.25 a foot per year - let's say $2 a foot per year. So a 5-year deal is $10 a foot, and a 10-year deal is $20. When it comes to TI incentives, the market rate is $5 a foot per year, so 5 years would be $25 and 10 years would be $50. One more surprise is free rent, usually half a month to a month and a half per year, which on average is about $1 a foot per year paid upfront. So every office lease is very capital intensive on the front end. Between commissions, tenant improvements and free rent, one new 5-year lease will cost you about $40 a foot, and a 10-year lease about $80.
That was new to me, coming from industrial, where commissions on a 5-year lease are $0.60-$0.70 a foot per year, TI is maybe new paint at $1-2 a foot total, and there's typically no free rent.
Now what's good about it is that lease rates in office are much higher compared to the basis, so you have a huge spread. And in the last five years post-COVID, lease rates didn't drop as dramatically as purchase prices per foot. Also, cap rates on office are 10% or more, and if your deal has a story of improvement and your bank sees the vision, your debt will be in the 6s, which gives you 400+ basis points of free cash flow on day one.
So really, what I see in office is two big positives. Purchase prices are dramatically lower compared to lease rates than in other asset classes, and cap rates are so much higher, which gives you a strong margin between your debt and your cap rate. The art becomes how you value engineer tenant improvements, leasing commissions and free rent. If you can roll up your sleeves and optimize it as an operator, it becomes an operating business, not really a real estate play, and from a cash flow perspective the numbers are the fattest I see right now.
So those are a few observations from week one of going deep in due diligence on our new office park. I'll share more as we progress through the acquisition. And for any of our readers who is an accredited investor, eyeballing a value-add play in office, and wants to be part of our deal, I'll be hosting a webinar on Thursday, October 8 at 10:00 am. Click here to register.
If you own or lease office, what are you seeing on TIs, commissions and free rent for a new lease in your market? Hit reply - I want to compare notes with what we're seeing in Chicagoland. I read every one.
LET ME HEAR IT
Thank you for reading.
Until next Sunday.
Be well,
Saul
P.S. Missed my podcast with Gary Lipsky? Here is the full episode.
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