12) Lions, Tigers and Bear Markets, Oh my!
With the Feds raising interest rates another 75 bps, we are officially in a bear market. That, in turn, is causing a slowdown in the commercial real estate industry. However, all commercial assets will not be equally affected by the downslide.
Experienced investors understand all too well that even though the national economic data may be all doom and gloom, real estate is affected by local and regional factors. Supply, demand, .and competition at the local level will determine the success of the asset. Keep in mind that all asset classes are not affected equally.
Interest rates will certainly have an effect on the multifamily sector, but that can prove to be advantageous for the smart investor. Since most commercial property loans have interest rates that reset every five years, a landlord that has mismanaged a multifamily property for the last five years and was still able to produce positive cash flows because interest rates were at 4%, may not be able to produce the same returns when interest rates jump to 7%. This is certainly a buying opportunity for investors. Additionally, as mortgage rates increase, buyers will shift from trying to purchase homes to renting homes. This also presents an opportunity for the higher-end A class properties.
Construction of new units will slow down since materials and labor are sensitive to inflation. Local market demand is more of a factor in rent increases rather than inflation, so a slowdown in new construction will cause an increase in rents which will push many renters into B and C class properties.
Other asset classes such as office buildings will have a harder time in this economy. The COVID-19 pandemic has provided the opportunity for remote work. However, those employees that were starting a part-time commute back to the office will now hesitate to go back to the office due to higher gas prices, especially in a city like Houston, TX where public transportation options are not ideal.
The hospitality and retail industries are very dependent on the employment sector. If unemployment starts creeping up, these sectors will start seeing a slowdown. However, as of today, the job market is still pretty robust and consumer demand rose 0.9% in April, despite inflation.
Even with higher interest rates, there are many buying opportunities in the real estate sector. Detailed due diligence and conservative underwriting are the key.