The events unfolding in the North Bay’s commercial real estate market exemplify the concept of creative destruction. This economic theory, as observed in the region, is demonstrated by the closure of long-standing retail stores and entertainment venues, which are giving way to emerging industries and changing consumer preferences.

What is “Creative Destruction”?

Creative Destruction describes the process where new innovations replace and render old innovations obsolete. The departure of national retailers like Burlington, Bed Bath & Beyond, and Forever 21 from the North Bay region points towards a shift in retail dynamics. This is likely a response to the changing nature of consumer shopping habits, where e-commerce is becoming more dominant, leading to the consolidation of brick-and-mortar stores.

It is not just big box retail that is changing. The decision by Bank of America to not renew their downtown Petaluma contract indicates a move towards digital banking services, as more consumers manage their finances online, reducing the need for physical bank branches.

The transformation of Pepper’s restaurant into a medical clinic and the closure of movie theaters in San Rafael and Rohnert Park reflect a reallocation of real estate to services that are in demand, like healthcare, at the expense of traditional entertainment venues, which have been heavily impacted by digital streaming services and changing leisure habits.

Conversely, Amazon’s planned expansion of their Vacaville complex to 2.1 million square feet signifies the growth of the e-commerce sector, necessitating larger distribution and fulfillment centers. This is a direct response to the increase in online shopping and the need for efficient logistics networks.

What does this mean?

These changes in the North Bay area are indicative of creative destruction, where outdated business models and less efficient uses of real estate are phased out to make room for new, more profitable industries that better reflect current economic trends and consumer behaviors. This process, while often disruptive in the short term, is a natural part of economic evolution and can lead to a more dynamic and resilient economy in the long run.  The concept of creative destruction, as observed in the North Bay area, is a critical and natural part of an evolving economy. It’s a process that allows for the reallocation of resources to more productive and innovative uses, which can lead to overall economic growth and increased efficiency. Here’s how this process can be beneficial in the long term:

 

  • Reallocation of Resources: When businesses close or relocate, their former premises don’t remain unused; they often become opportunities for other businesses. For example, a closed restaurant turning into a medical clinic represents a shift in resource allocation from one sector to another, potentially more in-demand, sector.
  • Technological Advancement and Innovation: The expansion of Amazon’s facilities in Vacaville reflects the growth of technology-driven commerce. Such innovations often lead to new business models and job opportunities, including roles that didn’t previously exist, thereby contributing to economic diversification and resilience.
  • Productivity Increases: The shift away from traditional brick-and-mortar retail toward e-commerce can lead to increased productivity, as e-commerce platforms often provide broader reach and higher efficiency than physical stores.
  • Consumer Benefits: Changes in the economy often come with advantages for consumers, such as greater convenience, lower prices, and a wider array of services and products.
  • Job Creation: While some jobs may be lost in sectors that are contracting, new jobs are created in expanding sectors. Over time, the workforce adapts through retraining and upskilling, leading to a more skilled labor force.
  • Growth: Creative destruction can lead to overall economic growth. New industries often grow at a faster rate than the ones they replace, contributing to a higher Gross Domestic Product (GDP).
  • Social Adaptation: As society adopts new technologies and changes its consumption patterns, the economy adapts to meet these new demands. This adaptation is crucial for long-term social and economic well-being.

 

In the context of creative destruction, the economic landscape is often likened to a game where there are winners and losers, which is a fundamental aspect of market economies. This competitive process is driven by innovation and the constant pursuit of efficiency, which inevitably leads to shifts in who benefits and who does not.

Commercial real estate investments are strong for a number of reasons. First, commercial properties tend to have higher cash flow than residential properties. This is because commercial properties are often leased by multiple tenants, which means that there is a steady stream of income coming in. Second, commercial properties tend to appreciate in value over time. This is because the demand for commercial space is usually growing, which means that there is more competition for properties. Third, commercial real estate investments can provide tax benefits. For example, investors can deduct the depreciation of their properties from their taxes.

Commercial real estate investments can be a great way to generate income, build wealth, and save on taxes. If you are looking for a strong investment, commercial real estate may be a good option for you.

Here are some additional details to support the points made:

  • According to the National Council of Real Estate Investment Fiduciaries (NCREIF), the average annual return on commercial real estate investments over the past 15 years has been 12.7 percent, compared to the S&P 500, which has had an average annual return of 8.8 percent.
  • Commercial real estate investments can provide a steady stream of income, as tenants typically pay rent on a monthly basis.
  • Commercial real estate investments can appreciate in value over time, as the demand for commercial space continues to grow.
  • Commercial real estate investments can provide tax benefits, such as depreciation deductions.

If you are interested in investing in commercial real estate, it is important to do your research and consult with an advisor at Keegan & Coppin to determine if this is the right investment for you.

The real estate market is constantly evolving. It’s influenced by various factors such as economic conditions, market trends, and investor sentiment. As such, forecasting the capitalization rate of  property types such as office, industrial, and retail properties, requires careful analysis and consideration of multiple variables. We at Keegan & Coppin will delve into the North Bay Area real estate market and provide an estimated 5-year forecast on the capitalization rate of these property types.

The North Bay Area, known for its picturesque landscapes and proximity to major metropolitan areas such as San Francisco, has long been a desirable location for real estate investors. However, like any other market, it is not immune to fluctuations and changes. Let’s take a closer look at each property type and their respective capitalization rate forecast.

Office Properties: The office market in the North Bay Area has historically been strong, driven by demand from various industries such as technology, healthcare, and professional services. However, in recent years, the office market has experienced some challenges due to changing work dynamics, including the rise of remote work and flexible office space options.

Over the next 5 years, it is expected that the capitalization rate for office properties in the North Bay Area will experience some upward pressure. This can be attributed to potential oversupply in certain submarkets, as well as the continued uncertainty around the future of office space demand. As remote work becomes more prevalent and companies reassess their office space needs, some investors may demand higher returns to compensate for increased risk. However, prime office properties in prime locations with strong tenant profiles are likely to remain resilient, and the impact on capitalization rates may be moderate.

Industrial Properties: The industrial market has been a standout performer in recent years, driven by the growth of e-commerce and logistics. The North Bay Area, with its proximity to major transportation hubs and favorable business environment, has seen strong demand for industrial properties from companies looking to expand their supply chain operations.

Looking ahead, the industrial market is expected to continue its upward trajectory, with the capitalization rate for industrial properties in the North Bay Area projected to remain relatively stable or even decline slightly over the next 5 years. The ongoing growth of e-commerce, the need for last-mile distribution facilities, and limited supply of industrial properties are expected to support continued investor interest in this property type, potentially leading to compressed cap rates in prime locations.

Retail Properties: The retail market has faced challenges in recent years, with the rise of online shopping and changing consumer preferences impacting brick-and-mortar retail. The North Bay Area, with its unique mix of urban and suburban environments, has experienced varying trends in the retail sector.

Forecasting the capitalization rate for retail properties in the North Bay Area is challenging due to the changing dynamics of the retail market. While some well-located retail properties with strong anchor tenants may continue to perform well, others may face higher vacancies and increased risks. As such, the capitalization rate for retail properties in the North Bay Area is expected to be mixed, with potential variations depending on the location, tenant mix, and property condition. Overall, the retail market is likely to face some headwinds in the coming years, which may result in slightly higher capitalization rates for certain properties.

In conclusion, the North Bay Area real estate market is expected to face some challenges and opportunities in the next 5 years. While the industrial market is projected to remain strong, with stable or even declining capitalization rates for industrial properties, the office and retail markets may experience some upward pressure on cap rates due to changing demand dynamics and increased risks.

As with any investment, it is crucial for investors to conduct thorough research, analysis, and due diligence before making any business decisions.

Santa Rosa is the largest city between Portland and San Francisco with an estimated population of 175,000. It serves as the county seat for Sonoma County which is known worldwide as a leading wine region and has become a major player in the up and coming craft beer industry. Along with the agriculture the region is famous for; Santa Rosa is also home to other industries including high-tech, biomedical, manufacturing, education, tourism, and various other professional and personal services. The labor market has bounced back with companies hiring new employees. This is evidenced by an unemployment rate of just 4.7% down from the double digit rates we were experiencing at the height of the recession. There is a quality of life in Sonoma County that drives residents and companies alike to the region. This creates an environment for prospering business with Santa Rosa serving as the economic hub.

The major business parks and shopping centers put together the bulk of the base occupancy in the region.  In South Santa Rosa there is the Industry West Industrial Center and the Oak Manor Industrial Area which have many large manufacturing warehouses, as well as the Northpoint Corporate Center with a mix of Office and Industrial.  In Central Santa Rosa there is a vibrant downtown area with a mix of office and retail as well as the nearby Santa Rosa Business Park and the Stony Point Office Park which both have large multi tenant office buildings.  Further north is the airport area with parks such as the Airport Business Center and Westwind Business Park which have a mix of office and industrial uses.  Santa Rosa is also home to three shopping malls which together house over 200 merchants.

The economic recovery has accelerated over the past few years; particularly the industrial and retail market and high occupancy rates have allured investors to these product types. Santa Rosa has over 16,000,000 square feet of industrial buildings with a current vacancy rate of approximately 8% and almost 8,000,000 square feet of retail buildings with a vacancy rate of approximately 3.4%. These low vacancies have attracted investors and we are seeing more competition for available investments and lower cap rates which make it a great time for owner’s to consider selling.  The office market has been slower to recover with a vacancy rate of 16% in over 9,500,000 square feet of office buildings.  This also provides great opportunity for owner-users to be able to buy a vacant building for their business and take advantage of the still low mortgage interest rates.