Key Events Impacting Commercial Real Estate Investors in July 2024
As we navigate through 2024, the commercial real estate market continues to present new challenges and opportunities. Here are some of the critical factors shaping the landscape in July 2024.
Higher Interest Rate
One of the most significant factors currently influencing commercial real estate is the ongoing volatility in interest rates. After a period of historically low rates, we’ve observed a gradual increase over the past few years. The Fed has held rates steady and indicated we may see one reduction by the end of 2024.
Impact on Commercial Real Estate
The shift in the interest rate environment is having multifaceted effects on the commercial real estate market. As borrowing costs rise, cap rates are under upward pressure, potentially reducing property values. Properties that might have traded at a 5% cap rate in a lower interest rate environment may now be valued closer to a 5.5% or 6% cap rate.
Some deals that made financial sense in a lower interest rate environment may no longer be viable, forcing investors to be more selective and focus on properties with strong fundamentals and value-add potential.
Additionally, property owners with loans coming due may face challenges refinancing at higher rates, leading to an increase in distressed sales or forcing owners to inject additional equity to meet lender requirements.
Adjusting Underwriting Assumptions
Investors need to stress-test their models with higher interest rate scenarios. Using interest rate sensitivity analysis can help investors understand how different rate environments could impact returns. It’s crucial to factor in the potential for higher borrowing costs and adjust underwriting assumptions accordingly.
Focus on Fundamentals: Cash Flow
In a higher interest rate environment, properties with strong, stable cash flows become increasingly attractive. Investors should look for properties with long-term leases to credit-worthy tenants, which can provide a buffer against interest rate volatility. Ensuring that a property can maintain healthy cash flow despite higher interest rates is key to mitigating risk.
Value-Add Opportunities
Properties that offer potential for operational improvements or repositioning may provide better returns in a rising interest rate environment. By increasing NOI, investors can help offset the impact of higher borrowing costs. This involves looking for properties where strategic improvements can enhance value and profitability. And yes they do still exist. I’m doing one right now and so are several of our clients.
Alternative Financing Structures
Exploring alternative financing options such as assumable loans with long-term fixed rate debt, seller financing, or mezzanine debt can help mitigate the impact of higher interest rates on overall returns. You can also stack these solutions on top of each other. These strategies can provide more flexible financing solutions that align better with the current market conditions. Seller financing is the play right now.
Negotiate the Price
Rising interest rates may create opportunities for buyers to negotiate better purchase prices. We’re no longer in a sellers’ market. Sellers will have to adjust their price expectations to account for the higher cost of capital for buyers. And it’s up to you the buyer to press the issue even though most sellers are reluctant to cut their price.
Long-term Business
While the current interest rate environment presents challenges, it’s important to remember that real estate is a long-term investment. Historically, commercial real estate has performed well across various interest rate cycles. The old adage of spending time in the market is more important than timing the market holds true. Because we simply are very good at predicting the future. So invest on the fundamentals of buying at a discount and buying for cash flow and not appreciation still apply.