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What if this little commercial real estate reset is not as tragic as analysts might make it appear?

As we all know, real estate is cyclical.

In commercial real estate what that means to me is that sometimes more properties are selling and sometimes more properties are leasing. Business continues to go on, it just looks different depending on what’s happening with interest rates, supply and demand, and a variety of other things.

Investors have had it pretty good expecting long lease terms, good cap rates, and nice interest rates. The market has been booming in 2022, but now the interest rates are rising, and the investors are a little upset about the decrease in their return. As an example, I’m working with someone that has a building under contract at a 9.5% cap rate with a value-add opportunity. As part of the contract, the buyer required a 5% interest rate. This went under contract in April and since then there have been at least three rate hikes.

There were items in due diligence that resulted in a failure to quickly pull the trigger on the loan. Unfortunately, after the due diligence items were satisfied, the rates were no longer the same. The deal is still a great deal but may not be the slam dunk it was a few months ago.

Something worth considering is that just like we would have never predicted what happened over the past few years, we also cannot predict what will happen in the next few years.

The market could swiftly change in such a way that the properties appreciate in value. If the market shifts away from selling, the lease rates will increase. In which case it would be better to have shorter-term leases in place so that the landlord can increase the lease rates accordingly…which in turn could raise the price at the time of sale depending on a few other factors.

When the interest rates increase, the cash buyers are out in full force looking for deals. They know that their competition is much slimmer allowing them to pick up properties they wouldn’t normally pursue.

What if you are an owner/user and need to buy a building or sell a building right now? I would say it depends on your reasons. If you outgrew your existing space and need to find a bigger space, there will still be properties out there to choose from, but you need to be ready to move on them when you find them. With decreased inventory, buyers need to be decisive, or they will miss out on a good property.

If youare selling and are concerned about the asking price being lower, there are two things to consider.

1) If you are selling a vacant building to someone that needs the building, they are less likely to try to buy the building at an extreme discount, and 2) if you are selling an investment property with income, the price will be based on income. Cap rates may fluctuate, but ultimately, the price will be based on the quality of the leases and tenants you have in place. This may be a good time to restructure your leases so you can reposition your building for a sale as the market balances out in the near future.

Granted, these are just a few of my thoughts as we acclimate to the new higher interest rate environment, but we’ll see how things pan out. There are always commercial real estate deals to be found. You just may have to make some adjustments to your criteria.

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