Contributing Author: Jay Verro, CCIM
Wow, another year is coming to an end already! Time to start wrapping up year end closings, preparing for the holidays and looking ahead to 2019.
2018 proved to be the year of the Fed Rate Hikes! While rate hikes have been predicted for several years, they occurred this year. By comparison, the Fed Fund Rate was 1.0% in Q12017 and 1.5% in December 2017. In 2018, the first 3 quarters saw 0.25% increases with another 0.25% increase anticipated this month. It’s realistic that we’ll end 2018 at 2.5%. Many are forecasting another 0.5% increase in both 2019 and 2020, while others forecast a potential reversal in the continued upward rate trends.
With the upward mobility in rates, comes declining commercial real estate values to lenders and buyers. As 2018 winds down, there is still a disconnect between sellers and buyers on property valuation. With 5% + interest rates, it’s challenging to underwrite an income producing property the same way as even the beginning of the year. The market in general hasn’t corrected itself to the new Fed Rates, due in part to the lack of inventory of certain property types in different markets, the continued popularity of multifamily, industrial and self-storage investments and the lack of acceptance that the same NOI buys less of a commercial mortgage than it did at the end of 2017.
Lenders are lowering their Loan to Value (LTV) while raising their interest rates and Debt Coverage Ratio (DCR), requiring investors to have more skin in the game. This will alter the ability for many investors to meet the expectations of unrealistic sellers.
Example: $5,000,000 mortgage / 25 Year Amortization
5% Interest Rate = $350,754 Annual Debt Service
5.5% Interest Rate = $368,452 Annual Debt Service
6% Interest Rate = $386,581 Annual Debt Service
A 1% increase in interest as in the amount of increase in the past year has a $35,827 negative effect on the NOI for the example property. To quantify that into a value difference – at a 6% cap rate, the property’s value decreased by $597,117
Takeaways from 2018 include:
- not every property appreciates in value
- it is very important to control as many other expenses as possible
- evaluating your hold period strategies
- whether you should sell your fully depreciated investment property and 1031
- consult with your experienced commercial real estate professional to create a game plan that works for you / your ownership entity
- the moniker that “Cash is King” may be coming back around as rates rise
As we look ahead to 2019, it’s a great time to shop around for competitive pricing on your controllable expenses such as: trash removal, landscaping, property insurance, etc. Think of the winter months as Spring Training to position your property into its most valuable position. A yet unknown bright side to 2019 and beyond is the upcoming changes in the Financial Accounting Standards Board’s (FASB) Leasing Accounting Standards. CFO’s will likely start looking harder at whether it’s better for their company to buy vs. lease moving forward.
Our brokers at NAI Platform possess extensive knowledge and experience of the industry’s intricate nuances, with a singular focus of working diligently to help our clients meet and surpass their goals.
For more information and expert guidance on your commercial real estate needs, please give us a call at NAI Platform or visit our website at www.naiplatform.com.
Happy Holidays and Best Wishes for an Amazing 2019!
James “Jay” Verro, CCIM
14 Corporate Woods Blvd.
Albany, NY 12211
Direct: 518-465-1400 Ext: 214
Fax: 518 465 1441