Our Commercial Market Roundtable is back to bring you updates from Q2. We’re talking about what’s going on in the market and looking at some interesting data on what happens to cap rates when interest rates rise and fall.
Joining me in the studio are:
- Tom Konkel of First Integrity Title
- Travis Sperr of Renovo Financial
- Kevin Woolsey and Will Scherman of Kaufman Hagan Commercial Real Estate
Although William Foy and Marcus Davis of Spearhead Commercial Capital couldn’t join us, they sent us some interesting information on how they’re helping clients as interest rates rise.
To hear the full discussion, check out the podcast or YouTube video.
- Listen to the podcast “#398: “The Sky Isn’t Falling”: Why the Commercial Real Estate Market Is Stronger Than You Think ” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
How Are Rising Interest Rates Affecting Deals?
Kevin is seeing a shift in how people are approaching deals. Now, they’re spending more time thoroughly underwriting properties and shopping around for the best lending terms. Instead of assuming they can buy a property, sit on it, and reap the benefits of appreciation, sophisticated investors are putting in more effort to invest in properties.
Tom has been through these cycles before and has seen less savvy operators weeded out. This is a time for people who are really focused on value-add to make good returns because they know what they’re doing.
Because Tom works in title, he sees all kinds of deals and knows what’s working and what isn’t in today’s market. Due to rising interest rates, the residential resale and refinance market has dried up. He’s seeing first time homebuyers and move up homebuyers significantly impacted. In the commercial market, deals that are $7MM and under are being repriced, but the bigger deals, $25MM and under, aren’t falling out or getting repriced.
What’s the Impact of Interest Rates on Cap Rates?
Lon Welsh gathered data on every time interest rates spiked or dropped more than 1% over the past 40+ years. He found that when interest rates spiked more than 1%, cap rates fell by 0.1%, and when interest rates dropped that amount, cap rates again only rose 0.1%. I was surprised by how little cap rates are affected by interest rate shifts.
Travis says these trends show that there’s a lot of money out there and people continue to invest in real estate. He’s seen that properties are starting to require 65% loan to value, as opposed to the usual 70%-80% loan to value because of rising rates.
Advice to Investors
William and Marcus sent over the top three recommendations they’re making to clients right now. They expect that interest rates will continue to rise throughout the year, and investors run an interest rate risk while waiting to close.
Their top 3 recommendations to negotiate a rate “lock” or ‘hold”:
- Offer up a deposit relationship or a reserve account with the lending institution.
- Provide solid sponsorship/equity-partners through personal guarantees, additional disposable income and excess liquidity will be favorable.
- Consider lowering the risk profile of the transaction by coming in with low leverage/LTV and therefore over performing cash flow/DSCR.
New Build Labor Shortages and Supply Chain Issues
Will points out that new build developers are facing a huge labor shortage of hundreds of thousands of workers across the country. Material costs are increasing, too, further complicating logistics for developers. This is causing them to struggle to keep pace with the population growth. It raises the questions of how to make the cost of building cheaper, and what’s the give and take between the private and public sector.
The market is drastically affecting how developers are forming strategies. Tom is talking to developers who are looking to change the product type they’re offering. Instead of creating a 300-home subdivision to sell, they’re looking to build homes to rent out. Further, Will spoke with another developer who says their designs are being dictated by what’s available in the supply chain instead of what they know will sell.
How Is Affordability Affecting the Market?
Tom reminds us that affordability is a huge issue right now. The people he’s spoken with who work in affordability are at 100% capacity with a waiting list.
In Denver, the average home price is $650K, 20% of which is $130K; that’s a pretty big wall to climb for first time buyers. Will says that we’re short of affordable units by tens of thousands. Because of the shortages in people and supplies for new builds, it’s not possible to build at a faster rate.
Travis adds that different municipalities place restrictions on how many buildings can be built, which can make it difficult for developers. In Lakewood, developers struggle to get permits even when lots are already vacant and developing them would bring people and revenue into an area.
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