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The Fed, Interest Rates And The Good News For Commercial Real Estate



Federal Reserve officials plan to keep interest rates low until the economy firms.

The Federal Open Market Committee left interest rates unchanged at its April 27-28 policy meeting, and reaffirmed its commitment to keep rates low until the economy has recovered more fully from the pandemic. Rates are at historical lows, however, and will certainly move higher as the economy gets back to pre-pandemic levels of activity. Some observers have expressed concern about the impact of higher rates on commercial and residential real estate markets. Most of the evidence, however, suggests that the rate environment will remain favorable for real estate.

Most people are familiar with the effects that interest rates have on housing markets. Lower rates on home mortgages reduce the financing cost of a home purchase, and often spur home buying, new construction, and increases in house prices. We are currently in the middle of a housing boom, fueled in large part by current low mortgage rates. Of course, this process can work the same way in reverse, and higher mortgage rates generally slow home buying and cool the housing market.

The same forces are at work in commercial real estate, as properties are frequently financed with commercial mortgages. As a result, commercial real estate markets are often considered one of the sectors of the economy most exposed to interest rates. The current risks are not large compared to previous periods, though, as in many property sectors debt loads are more moderate than in the past.

The two biggest factors for the outlook for long-term interest rates (which have the most direct impact on commercial real estate markets) are economic growth and the likelihood that such growth will lift inflation higher. Economic activity is expected to rebound over the spring and summer as the vaccine rollout helps slow the spread of Covid-19, allowing businesses and consumers to begin getting back to pre-pandemic normal. Many economists expect the economy to grow at a 6% or faster annual rate over the remainder of this year. To the extent that faster growth generates higher inflation, it also generates higher business activity and demand for commercial space, higher occupancy rates, higher earnings for commercial real estate, and higher property valuations. These higher earnings generally offset any drag from rising interest rates during periods when growth accelerates.

Inflation is indeed likely to move higher as growth accelerates. Concerns about inflation risks first began to surface as Congress debated the $1.9 trillion fiscal stimulus package in February. Former Treasury Secretary Lawrence Summers warned that the magnitude of this stimulus could push the economy beyond its potential, fueling inflation pressures.

Financial markets have responded to this stronger growth environment, and long-term interest rates have already begun moving higher. The yield on the 10-year Treasury note rose from just above 1% in late January to 1.75% at the end of March.

Commercial real estate is likely to be resilient, however, for a whole host of reasons, including macroeconomic factors, economic policies, and financial conditions within commercial real estate markets. Let’s take a look at the most important factors.

We are in a low-inflation, low-yield, low-interest rate world

This isn’t That ‘70s Show or even that sixties show when it comes to inflation risks. There is by no means a consensus that the coming pickup in growth will push inflation too high; in fact, many economists (including me) expect inflation to remain moderate. There are cyclical, structural and policy reasons why the inflation outlook is benign:

Cyclical factors will be transitory

Inflation will move higher over the next 12 months due to base effects. This is because comparisons for price changes versus year-ago will be looking back to the first few months of the pandemic, when prices were temporarily depressed by unusual weakness during the shutdowns. This will give an artificial boost to the reported 12-month inflation rate, but this higher reported inflation rate is not the start of an inflationary spiral.

More important for the medium-term outlook, the overheating of the 1960s and 1970s resulted from years and years where the economy was pushed above potential GDP—the economy’s “speed limit.” Joseph Gagnon at Peterson Institute for International Economics has pointed out that the fiscal boost from spending on the Vietnam War was long lasting, stretching out for many years, while many parts of the current fiscal stimulus are a temporary response to the current economic crisis. As these components of the stimulus fade in the years ahead, so will inflation pressures.

Structural changes to the economy affect price dynamics

During the Great Inflation of the 1960s and 1970s, the economy was heavily reliant on manufacturing and energy-intensive businesses. These types of production processes were more prone to bottlenecks that pass along price pressures, including energy costs, than today’s information economy. In fact, the concept of “capacity” is poorly defined for, say, software engineers compared to auto assembly lines. In addition, economic activity in those days was much more heavily regulated, which limited its ability to respond to shortages in a way to head off price changes. And finally, the role of price expectations, and the inclusion of cost-of-living clauses in many employment and commercial contracts, helped perpetuate inflation pressures in the 1960s and 1970s in a way that is not widespread today.

Monetary policy is more proactive

The Fed is already discussing how it plans to respond as the economy firms. This is a sharp contrast to the 1960s and 1970s, when the Fed waited until inflation rates had already moved significantly higher before they began raising interest rates. As my grandmother used to say, a stitch in time saves nine.

Commercial real estate entered with pandemic without the imbalances of decades past

Commercial real estate markets in the past had been vulnerable to three types of imbalances: overbuilding, overheating, and over-indebtedness. None of these three factors was a major risk on a national basis, fortunately, when the pandemic hit. This more stable footing for the sector has helped commercial real estate be resilient through the crisis and provides conditions more conducive to recovery ahead. 

New construction was moderate prior to the pandemic, especially in office and retail property markets. Completions of office buildings in the twelve months prior to the pandemic represented just 0.7% of the existing stock, according to data from CoStar, well below the 1.5% at the onset of the 2008 financial crisis, or the 2.5% new supply during the 2001 recession. New construction of retail properties was almost nonexistent, at 0.4% of existing properties. Vacancy rates are rising and rents have been weak or falling due to cuts in demand for commercial space, but the impact nevertheless is smaller than it would have been with a heavy construction pipeline. The low levels of supply will be important for the recovery ahead.

In addition, prices did not have much speculative froth. Capitalization rates are low pretty much across the board, but interest rates are low, too. The spread between cap rates and Treasury yields—which is the return investors receive to compensate for holding real estate—have remained comfortably wide. This will help cushion commercial real estate prices from moderate increases in interest rates.

Finally, debt burdens did not appear excessive prior to the pandemic. There have been delinquencies and defaults among businesses that saw cash flows disappear during the shutdowns, but there have also been surprises at how resilient many property owners have been to these stresses. A more cautious approach to debt underwriting after the financial crisis of 2008-2009 helped avoid repeating some of the mistakes of the past.

REITs provide a window into an important part of the commercial real estate universe. As publicly listed companies, REITs have a degree of transparency into financial conditions that is lacking among private real estate investors. REIT balance sheets are robust, having lowered their leverage over the past decade from a high of 58.2% debt-to-book asset ratio in 2008, according to the Nareit T-Tracker, to less than 50% today (full disclosure: I am senior economist at Nareit and created and maintain the T-Tracker database). Together with low interest rates this has resulted in interest payments at a record low share of net operating income (NOI). REITs, and much of the rest of the commercial real estate sector, are well prepared for moderate increases in interest rates.

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Real Estate

13 Tips For Real Estate Investors Crafting An Exit Strategy



Photos of featured members.

Real estate investors know that not every purchase they make is going to be a win. In a few cases, you’ll end up with a dud, where a property that looked good at first ends up being more trouble than it’s worth once you’ve bought it.

This is why no investor should go into a property purchase agreement without having at least one clear exit strategy defined. To help avoid a bad purchase before it’s too late, 13 experts from Forbes Real Estate Council share critical steps all real estate investors should consider to craft their exit strategy from the moment they start scoping a property out.

1. Understand The Current Financials

It’s important to understand the current financials of the property. From this you can model a multiyear pro forma focusing on the value enhancements you plan for the property. Based upon that model, you can project a valuation for the property at some point in the future. This process should help clarify the investment potential for the property. – Mark Tiefel, Capital Equity Group, Inc.

2. Set Clear Objectives Before Investing

Know your objective before investing in a property and establish your goals for any property you’re considering. This helps identify what success looks like for a property you want to invest in, which will help map out your exit strategy. Committing to a property without a clear objective and “winging it” after you commit to it typically ends up costing a lot of money and time. – Jim Brooks, The Brooks Team – EXP Realty

Forbes Real Estate Council is an invitation-only community for executives in the real estate industry. Do I qualify?

3. Consider The Future Buyer Persona 

Know your buyer. Always have the future buyer persona in mind when you are buying an asset. If you know your asset will attract syndicators, for example, then make sure to renovate no more than 50% of the property so you can leave meat on the bone. If you buy a larger asset, you can renovate 100% of it and then sell it to an institutional buyer who normally doesn’t like to execute a value-add plan. – Ellie Perlman, Blue Lake Capital LLC

4. Check Tenant Laws And Sale History

I believe that when purchasing any property, investment or not, you should buy with an exit strategy. Real estate is an investment that is used to create wealth. Look at local tenant laws, development in the area and rental rate history. If new inventory is coming, then rents will decrease. Check sale history for the last five years for trends. – Steven Minchen, Minchen Team/Elevated Living Network, Inc

5. Stress-Test The Deal At Purchase

Any good exit plan starts with stress-testing the deal at purchase. There are many factors in stress-testing a deal but here are a few to consider: 1. Never run out of money, so plan accordingly; 2. Increase the vacancy to at least 25% for the duration of hold and verify that the expenses can still be paid; 3. Increase the exit cap rate by at least 10 basis points per year of hold. – Chris Roberts, Sterling Rhino Capital

6. Plan For The Worst-Case Scenario

Always plan for the worst-case scenario when trying to exit. It’s really that simple. After proper planning and extensive research, determine what the worst-case exit strategy is. If you can stomach the worst-case scenario, then move forward and commit to the property. – Ben Grise,

7. Buy A Property That’s Easy To Sell

Buy a property that will be easy to sell. I prefer single family homes over condos because there is more buyer demand. Homeowners Association dues can also go up as condos get older and/or there can be special assessments for repairs which can make a property harder to sell. Assess the location—does it back to a commercial property or a railroad that may make it hard to sell? Does it have a good floor plan? Be picky! – Kristee Leonard, The Leaders Realty, LLC

8. Have A Multipronged Exit Strategy

Commercial real estate is evolving quickly before our eyes. Having a multipronged exit strategy approach to real estate investment is necessary. Don’t follow the headlines but look for the trend lines. Underwrite an asset traditionally but also underwrite the property in a nontraditional way. Look for one to two scenario analyses considering what happens if a market, sector or demand trend changes quickly. – Jacob Bates, CommonGrounds Workplace

9. Have At Least One ‘Weasel’ Clause

A “weasel” clause is a clause that allows you to exit, even when you’ve made the mistake! Resist the temptation to overdue. You need one. My personal favorite is “subject to the approval of the hard money lender.” Only once in 20+ years have I had to exercise this weasel clause to get out of a deal, but when I did, it was literally 10 minutes before closing. – Sherman Ragland, The Realinvestors®️ Academy, LLC

10. Have Multiple Exit Strategies

Having multiple exit strategies helps protect you from losing money on a deal. If you buy a house to flip but cannot get the price you anticipated to make a profit, if you’re able to rent it out instead, you’ll protect your investment. Unfortunately, if you get in a deal with only one exit strategy and that strategy does not work out, you will find yourself in a risky situation. – Chris Bounds, Invested Agents

11. Check Out Average Days On Market

Find out what the average days on market are for comparable properties throughout the year prior to your purchase. You will then have a good indication of when would be the best month of the year to resell the property for its highest and best price and for the shortest amount of time for an effective emergency exit strategy. – Mor Zucker, Team Denver Homes – RE/MAX Professionals

12. Hire A Home Inspector

Hire an excellent home inspector. These professionals are priceless! Sure, they can alert you to big red flags but they can also point out a lot of “minor issues” to consider. An itemized list will let you know exactly when to exit if a particular task takes more resources than you expected. Feedback from a professional inspector can help you “exit well,” minimizing losses and maximizing gains. – Michael McMullen, Prominence Homes and Communities

13. Remove Emotion From The Equation

Always remove emotion from the equation and perform unbiased, clear-headed due diligence without a lot of rosy scenarios. Be conservative with your valuation and repair estimating—often, investors value too high and underestimate renovation costs. Sometimes the best strategy is to walk away from a deal rather than spending the next several months wasting time and resources on a low-margin deal. – Nick Ron, House Buyers of America

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Real Estate

Digital Mortgage Lender Announces Softbank-Backed SPAC And $7 Billion Valuation



SoftBank founder and Chief Executive Masayoshi Son invested in Better during his search for 'fast-growing pre-IPO companies'.

The Softbank-backed digital mortgage lender Better announced yesterday its intention to join a SPAC with The Aurora Acquisition Corp., in order to take Better public. The transaction is expected to close in the latter part of 2021. This merger gives Better an implied equity value of approximately $6.9 billion and a post-money equity value of approximately $7.7 billion, as stated in the announcement. 

A subsidiary of SoftBank Group Corp., SB Management Limited, will bring $1.5 billion private investment in public equity (PIPE) and Novator Capital, the sponsor of Aurora Corp, will invest $200 million through the same method. Activant Capital, an existing investor in Better, will also participate in the PIPE for an undisclosed sum. 

Only a month ago Softbank invested $500 million in Better, leading to a valuation of $6 billion.

Better’s strong financial footing is no doubt a direct consequence of its success due to the covid pandemic’s double influence of sustained low interest rates over the past year and the need for consumers to be able to close on transactions without having to meet in-person. Last March, when the pandemic’s impact began, Better had a 200% increase in applications compared to February and a total of over $1 billion in closed loans during the month, which is more than the four-year-old company closed for both 2017 and 2018 combined. In all of 2020 they funded $24.2 billion in volume, according to the press release announcing the SPAC. 

Better, which has not been without some controversy, was founded in 2016 by Vishal Garg who was frustrated with the mortgage application process after losing out to a cash buyer when he made an offer on a home. He built the all-digital, multi-product platform to lower costs and speed up the process for buyers. Company marketing materials say their online process allows qualified customers to close in as little as two weeks.

The biggest takeaway from this news is how large the demand will be going forward for real estate transactions to take place in a fully digital manner. The pandemic has shown us that the market can continue with limited need for in-person contact and mortgage lenders of every size will have to improve their digital platforms if they want to stay competitive. The news about Better is only the beginning of a much larger trend.

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Real Estate

How Consolidated, Bundled Real Estate Offers Can Serve Homebuyers



Close up hand of man signing signature loan document to home ownership. Mortgage and real estate property investment

Amit Haller is the Co-Founder & CEO of Reali, a high-tech, high-touch real estate company founded in 2016. 

When homebuyers make the largest financial decision of their lives, they want the best options that take the pain out of the real estate process. They’re ready to focus on the details that matter most to them — such as settling into their new home — and desire a simplified and streamlined process to get them there. In recent years, that’s come in the form of bundled real estate products, where consumers are eager to combine several steps into one.

At Reali, we’ve also seen this trend emerge across several industries, not just real estate. Bundles have become highly appealing to customers regardless of the complexity of the buying process, including purchase decisions around insurance, home appliances and video game systems. Bundling often means financial savings for consumers, but it also means less stress and time-consuming interactions with nuanced details. Essentially, bundles save time, money, and stress, and that’s exactly what real estate companies should do for customers.

Here are the top trends we’re seeing in 2021:

1. Consumers want to keep it simple.

Complex decisions take more time, and right now, most of us are stretched too thin to think through all of the details. The pandemic, as well as other personal and social concerns, have stretched our capacity to do everything we want to do, including daily activities such as working or running our household. At the same time, people are eager to move into the next phase of their lives, and we’re seeing them begin to move forward by holding their delayed weddings, buying new appliances or investing in a new home. Anything that makes the process simpler will help that transition.

In real estate, homebuying can be one of the most stressful transactions that people complete. They have to worry about real estate brokers, a mortgage, insurance, escrow, inspection and warranties, and all of that can require different companies and experiences to complete the final tasks. Consumers may get lost along the way or miss a critical detail right now as they begin to move toward a “new normal.” 

In an experiment by our partner agency, Next Step, consumers who saw real estate as complex were nearly three times as likely to say that they wanted a bundled experience. They wanted more ease in the process and a smoother experience to get to their end goal. Essentially, bundling can help people to make a decision sooner rather than later, experience less risk and stress — and actually enjoy the decision-making process of buying a home. Any bundled options that real estate companies can provide to free up customers’ time and stress could reduce the barriers for making a decision.

2. Bundling can increase the perceived value.

Homebuyers want the best purchase for their hard-earned dollars, which has become even more prominent in the past year. People have faced tough financial decisions, and many families are rethinking the priorities that they need in a home-work-school space. They’re looking for more value and an all-in-one solution that makes the financial decisions easier and more transparent.

In the Next Step study, people said that, compared to individual product offers, consolidated bundles seemed more valuable, more popular and more preferred than other options, which plays to our psychological needs for belonging and smart decision-making.

Bundles also decreased costs. On average, people can save nearly 16% by bundling homeowners and automotive insurance policies, according to a 2015 Insurance Quotes study. Those who combined condo and car insurance saved about 11%, and those who bundled car and renters insurance had an 8% discount.

Overall, bundling complementary products can lead to a cost-savings of about 8% for consumers, according to a marketing study from Fordham University. In addition, the researchers found, offers that make sense together can create greater consumer happiness, which is the ultimate goal. For real estate companies, this could mean pairing mortgage options with insurance options or legal services.

3. Consolidated offers can facilitate the decision-making process.

Customers have told us that the decision-making process seems more complex than ever. People have easy access to products and services across the country — even across the world — and that can lead to analysis paralysis when deciding on the best option. We’ve found that bundles can help people make those decisions, particularly in complex service industries.

For instance, in a 2019 Accenture survey of 47,000 consumers, half said they were interested in bundled services in healthcare, home security, car care, personal finance management and homebuying. In real estate in particular, they voiced a need for end-to-end homebuying services, including advice on finding a new home, securing a mortgage, using legal services, buying insurance, and getting help with the moving process.

Ongoing survey data show that this trend has been increasing in recent years and became more popular throughout last year in particular. In the insurance industry, for example, consumers said they were seeking bundles so they could make better decisions and experience greater value from their options.

In fact, a 2020 survey by Deloitte found that consumers said offering non-insurance products was the most important factor when choosing an insurance provider. They said it added value and created an extension of the core products, so consumers wanted to buy them. In real estate, this requires rethinking the conventions around what products to include and creating innovative options.

Ultimately, we need to keep consumers in mind when considering the best ways to serve them in the homebuying experience. Their concerns come out loud and clear, with a need for simpler decisions, a smoother decision-making process and bundled packages that increase the value of their purchasing power. Real estate leaders should step up to provide these consolidated offers to clients and guide them along the successful path to homeownership.

Forbes Real Estate Council is an invitation-only community for executives in the real estate industry. Do I qualify?

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