Welcome
to our glorious SoCal fall! As days shorten, leaves crunch underfoot, and
temperatures cool - our commercial real estate market faces several headwinds.
Hamas’ blatant attack upon Israel, the ouster of our House speaker, and the ten
year bond yields at twenty year highs headline the obstacles. The first two -
Israel being attacked and patticake in the House of Representatives create
uncertainty. As I’ve said here many times - in the face of uncertainty, long
term decisions are postponed or scrapped entirely until things level. But
mortgage rates at highs not seen since the financial meltdown of last decade
creates gridlock in the housing market. As residential transactions ebb, we
feel it commercially. How you may be wondering? Allow me to expand a few
scenarios.
Turnover
generates commerce. My mind is drawn to the pre-pandemic spate of deals in our
small enclave of houses in East Orange. On our street, my wife and I have owned
our address second longest. Kitty corner to us are original owners since 1984.
Their multi-generational set up remains today - only with a new gen. But
lately, several of our neighbors tapped out for assisted living or passed away
- leading to four homes changing hands. Also, one rental converted into an
ownership. In every instance a dramatic interior redo occurred followed by a
freshening of the outside as well. So let’s break this down. First, a
transaction happened. In the process, real estate agents were deployed for the
buyer and seller. Staging, signage, glossy brochures, and touch up repairs
preceded the sale. Maybe a lawyer or two got a look at the contract. Then
escrow officers, title representatives, and lenders were engaged. Home
inspectors, termite companies, and moving vans were hired. Insurance for the
new digs was a closing component. And let’s not forget the bump in property
taxes which funds our county government. Once the deed records and title
transfers - an army of contractors descends upon the early 1980’s structure.
Paint, flooring, kitchen upgrades, bathroom remodeling, wall removal,
additional square footage built, etc. occur in earnest. The old furniture
surely can’t be set inside this pristine interior. So a trip to Living Spaces,
Daniels, or Mathis Brothers follows. Now an elderly couple - with limited consumption
- is replaced by a family of four or five. Groceries, gasoline, dry cleaning,
sports equipment, school clothes, orthodontics, urgent care, pets and pet
supplies, and Amazon home deliveries are all fueled by the new residents.
Commercial real estate activity is bolstered by the sale of houses! Please take
a moment to review the steps above. In every case - office, industrial and
retail are enhanced. Officed are residential real estate agents, escrow and
title plants, lawyers, physicians, and insurance brokers. Moving and storage,
all facets of contacting and landscape companies ply their trades in industrial
buildings. Finally, buying stuff. Yes! Retail storefronts or online portals.
Absent the turnover in houses, these businesses are forced to downsize, close
their doors, or look elsewhere for new work.
Rate
shock. The ten year treasuries eclipsed 4.8% last week for the first time since
2007! Great news for savers but lousy for those looking to buy a house,
refinance a mortgage, expand a business, or purchase commercial real estate.
Two years ago today, that same yield was 1.61%. Yes. Yields today are roughly
three times where they were two years ago. Savers in 2021 - in order to get a
reasonable return on their investments were forced to seek riskier assets such
as stocks, commodities or real estate. Now, backed by the full faith and credit
of the United States government, passive investors can make a nice risk free
return on their money. Avoided are the gyrations of the stock market or the downside
of real estate ownership - losing a tenant. However, this astronomic rise in
rates makes borrowing more expensive. Therefore, affordability in house
purchases becomes less so. If you’re among the unfortunate few who have
maturing loan balances to refinance - brace yourselves. Finally, expanding a
business becomes richer. Here’s what I mean. Banks price loans based upon their
cost of funds and the strength of the collateral. As we just discussed, a saver
can make 4.8% in treasuries so banks must raise certificate of deposit rates to
attract new money into their bank. Expanding an enterprise into an uncertain
economy could be viewed by some lenders as risky. Therefore, to hedge against
default, the rates charged must compensate. And the circle continues. For those
hoping to secure ownership in a location to house their operation - many will
encounter a debt service too expensive compared to a rental. More will find
leasing to be more affordable.
This
year, I’ve been quite bullish on our economy and the resilience of the
consumer. When others predicted a slowdown, I took the contrarian position.
Now, with student debt repayment ramping up after pandemic hibernation, home
savings balances declining, the government money spigot ending, high interest
rates ramping plus some new global unrest - I’m afraid a recession is
inevitable. When, how deep and how long remain questionable.
Allen C. Buchanan,
SIOR, is a principal
with Lee & Associates Commercial Real Estate Services in Orange. He can be
reached at abuchanan@lee-associates.com or 714.564.7104. His website
is allencbuchanan.blogspot.com.
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