Will McKenna, Progress Capital
"This rate is pretty high… can we lock it in?”
This statement would have seemed contradictory as little as six months ago, yet this was the exact response from a recent client when presented options for a refinance. The state of the current lending market is a bit frothy and moving quickly, and experienced borrowers and property owners are trying to move even faster. This week’s CPI numbers weren’t helpful either. The consumer price index rose 8.3% year over year and 0.1% in August. Investors will now most likely see a 75+ basis point increase in the federal funds rate next week. The Fed has indicated that their goal is to raise the Federal Funds rate to 4% by the end of the year, which will have a significant impact on commercial real estate financing.
The pandemic caused certain asset classes to shoot up in value, while others lagged significantly. Industrial went wild, while hospitality, office, and retail took a beating. Multifamily in major northern cities took a hit as renters fled to warmer climates that had better access to outdoor activities. Landlords from DC to Boston had to slash rental rates and increase concessions to keep their buildings occupied. Post-pandemic, we’ve seen the opposite trend, as rents in the New York metro area have come back with a vengeance and reached all-time highs, not just in Manhattan but the outer boroughs and Jersey City. Hotels are seeing occupancy rates similar to 2019 and 2020 levels and, while still off their overall peaks, companies are finally starting to push for a full return to the office for many employees.
In the upcoming higher rate environment over the coming months, a stabilizing effect should preside over all commercial real estate valuations. As interest rates rise, so do cap rates. Let’s face it – we’re staring a recession in the face and, with the exception of the dot-com bubble-led recession in 2001, property values have fallen in every other recession since 1973. Property values will fall.
Our key takeaway in discussions with clients is that interest rate volatility should be factored in when presenting offers to purchase commercial real estate. Long-term holders of CRE will use these market disruptions to pick up distressed real estate while pricing pressure continues to create opportunity.
What does this all mean? It means prices for CRE assets will fall over the coming months as interest rates rise. Savvy investors and real estate operators will have an opportunity that may only come around once a decade, and should capitalize if able.
Will McKenna is managing director at Progress Capital.