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Impact Of Rising Interest Rates Mixed On Commercial Real Estate

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The past two years were like nothing ever before seen in South Florida.

A period of record growth was fueled by inbound migration, strong consumer spending and record low interest rates — all of which drove billions of dollars invested in the development of millions of square feet of commercial real estate.

Much of this was brought on by the pandemic. Now, the pandemic has subsided and the South Florida CRE market has come to a moment of reckoning. Or has it?

The Federal Reserve has raised interest rates five times this year, including the increase of 75 basis points on Sept. 21, all in an effort to stem inflation. The Fed’s effort to keep the economy moving at the start of the pandemic led to the slashing of its target rate to 0%-to-0.25%. It remained there for the next two years, until March, when it set its first increase of 25 basis points.

The era of relatively cheap money for commercial and residential borrowers has come to an end. While the current rate of around 3% to 3.25% still is historically low, borrowing costs are at their highest level since 2019. In June, Federal Reserve Chairman Jerome Powell noted that the rate could reach 3.8% by late 2023. Simply put: These are the most aggressive rate hikes in generations.

This leaves developers and owners of office, industrial and retail projects to perform a delicate balancing and forecasting act incorporating borrowing costs versus long-term demand.

With borrowing costs rising, and fears of inflation and a possible recession looming, how will CRE across South Florida respond? It’s impossible to judge from how other markets are responding. Some have seen commercial projects tabled and vacancies rising, even if rents remain stable.

South Florida Is The Outlier In The CRE Marketplace

Development remains robust. Warehouse, logistics and industrial projects continue unabated from Homestead in the South and Palm Beach County’s Western expanse to the North, with numerous infill projects in between. Luxury rental apartments in hot markets, such as Brickell, Coral Gables, Fort Lauderdale’s Flagler Village and downtown West Palm Beach, are rising to meet the demand of the more than 800 new arrivals still coming to Florida daily.

Conflicts exist between remote workers and their employers calling for a “return to the office;” and with the hybrid workplace model continuing to evolve, future office needs remain unknown. Yet, the region has numerous dedicated and mixed-use Class A projects in development.

While the concept of “headwinds” comes up in any conversation about the unknown impacts of rising interest rates, inflation and the possibility of recession, South Florida and the state are outliers for other reasons. Whether through REITs (real estate investment trusts), private equity, hedge funds and other institutional capital seeking a solid vehicle for their funds; family offices and investors looking for a hedge against inflation; Latin American families seeking a less turbulent harbor for their money; those looking to real estate as a hedge against inflation; or developers bullish on local market prospects, Florida is rich with liquidity.

 

Source: SFBJ

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Why CRE Is Proving More Stable Than Stocks, According To One Expert

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The stock market has been on a tumultuous ride as of late, making commercial real estate even more attractive to investors looking for stability amid the chaos.

“I think it gives everyone a little heartburn to see the S&P 500 fall by more than 6% in a little over a week,” says Marcus & Millichap’s John Chang. “But the stock market has been on this trend for awhile.”

Specifically, the stock market is down by 10% over the last month and by 24% from the peak at the beginning of this year. And while it gained 27% in 2021, the losses this year have basically wiped out last year’s gains. The CRE market also had big pricing gains last year, according to Marcus & Millichap data, led by industrial at 17.9%, self-storage at 13.6% and apartment at 8.1% The difference?

“While the stock market peaked at the end of 2021, “commercial real estate kept going,” Chang says.

In the first half of 2022, the average industrial prices went up by 13%, self-storage went up by 10.5%, and hotels increased by 13.7%. Meanwhile, in the first half of 2022 the stock market fell by 20%.  The caveat, however, is that pricing is typically locked in 90 days before a deal closes, meaning second quarter pricing numbers were probably locked in before the Fed began aggressively raising rates.

Chang says the Fed’s press conference after its latest hike on September 21 “will probably impact” CRE pricing, “but the impact will be far less severe than what we’re seeing on Wall Street.”

“In general, CRE values tend to move more slowly than the stock market. They also tend to be less dramatic,” Chang says, adding that quarter-over-quarter pricing swings over the last 20 years have been “enormous” while commercial real estate pricing has largely remained steady.

Total annual returns also drive this point home, with CRE delivering a compound annual growth rate of 7.8% since 2000, beating the S&P at 5.3%.

“It still has its ups and downs, but its amplitude tends to be very modest compared to the stock market,” Chang says.

 

Source: GlobeSt.

Why Some Industries Are Moving First On Reshoring Back To U.S.

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Among the harsh lessons the pandemic taught industries is that relying on thinly sourced supply chains, particularly for manufactured goods, can be a mistake.

Something coming from that experience is a degree of reshoring manufacturing—bringing it back to the U.S., as Avison Young notes.

The push has been growing for “several years … with 1.3 million manufacturing jobs brought back to the U.S. since 2010.” Manufacturing grew by 21.6%, according to the Census Bureau, and new manufacturing facilities construction was up 116%. The reason is to diversify supply chains.

“Many companies are investing in domestic facilities based on lessons learned during the pandemic, as product shortages disrupted their business flow,” the firm wrote. “Recent intense pandemic lockdowns in China took many businesses by surprise and threw another jolt into the already disruptive supply chain. By locating facilities in the U.S., they can mitigate risk and gain more control over the production, quality and distribution of their products.”

Technology companies have been leaders in the push to reshore manufacturing. Examples are multi-billion-dollar chip plants, thanks to the $52 billion CHIPS and Science Act that was part of the Inflation Reduction Act.

The shift isn’t only the province of giant companies like Intel, Samsung, and TSMC.

“Many small- to mid-sized companies are also reshoring or expanding domestic manufacturing,” said the report. “Aside from the supply chain benefits, companies are also trying to work around skyrocketing shipping costs and other transportation costs. And, geopolitical issues related to China are prompting some companies to reduce their reliance on those foreign labor ties.”

With the increase of manufacturing facilities comes a boost to warehousing, because factories need storage and distribution space, as do tiers of suppliers to these manufacturers and potentially distributors.

“Despite the higher labor costs of operating in the U.S., it can be more cost-effective to manufacture products closer to the customer base, when reduced shipping and distribution costs are factored in,” the analysis noted.

An additional benefit that experts in supply chain and manufacturing logistics have noted for at least 20 years is shortening that by shortening the distance to a customer base, a company can react more quickly to changes in the market. Having factories in Asia and then shipping goods by sea leaves 30 to 60 days of inventory in transit, setting an effective time barrier on how quickly updates, design modifications, or error corrections can be incorporated.

 

Source: GlobeSt.