Tag Archive for: federal interest rates

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Brokers are giddy over the Fed’s announcement, while some caution fundamental challenges remain.

Commercial broker Jaret Turkell is ready to rock and roll. Turkell posted a GIF of Minions dancing with the tagline: “It’s time to PARTYYYYYY!” shortly after Federal Reserve Chairman Jerome Powell announced that the Fed was keeping interest rates unchanged, and signaled it would make three 0.25 percentage point rate cuts next year.

“We are back baby.  LFG!!!!!!” reads another tweet from Turkell, who focuses on multifamily and investment land sales at Berkadia in South Florida. (LFG stands for “let’s f**king go.”) The sentiment changed almost overnight,” Turkell said, tempering his initial enthusiasm a bit. “I’m not saying we’re back to 2021. Valuations will start to get a bit more attainable. Massive distress is going to be somewhat off the table, at least I hope so.”

The Fed’s decision is expected to boost confidence across commercial and residential real estate, especially in South Florida. The region has been somewhat insulated from headwinds in other U.S. markets since the Fed began hiking rates in the spring of 2022, but investment sales  volume is way down.

More than anything, the expected cuts are a sign of improving — not worsening — conditions. That could result in a boost of sales and financing in the second half of next year, brokers and attorneys say.

“Real estate is not a liquid asset, and it takes time for things to change. It takes time for that sentiment to build into transactions,” said Charles Foschini, senior managing director at Berkadia.

Still, the planned rate cuts won’t solve all problems, experts say. The high cost of insurance and construction will continue to hamper deals, brokers say.

“While South Florida maintains advantages over other major metros in the U.S., its biggest downside is insurance,” Foschini said.

Eternal Optimism Meets Reality 

Some pointed to the stock market rallying and the drop in inflation as breadcrumbs indicating that more good news is on the way.

“The signal that rates have stopped going higher and will go lower, psychologically is very impactful,” said industrial developer and broker Ed Easton. “But it’s not earth-shattering,”

In fact, most expected Powell would leave rates unchanged.

“No one was anticipating anything more than a standstill at this time of year,” said commercial broker and developer Stephen Bittel, chairman of Terranova Corp. The expected cuts are “not an enormously meaningful adjustment, but it does telegraph future expectations.”

Jaime Sturgis, CEO of Fort Lauderdale-based Native Realty, said he is already seeing that confidence translate into better terms.

“That will continue next year,” Sturgis said.

Still, asset classes like office and multifamily could suffer disproportionately, especially as suburban office tenants continue to downsize and multifamily landlords struggle to turn a profit.

“There will be pain and distress in that market, no question about it,” Sturgis said. “Some multifamily landlords and developers were already operating on razor thin margins to begin with. The smallest variations in that model can break it.”

Multifamily developer Asi Cymbal, who has projects in Miami Gardens, Fort Lauderdale and Dania Beach, agreed that rate cuts won’t solve major problems, such as if a developer overpaid for land.

But, Cymbal said, “the worst is over.”

Cymbal and others expect more groundbreakings in 2024, with some self-funding initial construction, expecting that they can secure a loan. He plans to self-fund the groundbreaking of Nautico, a $1.5 billion mixed-use development fronting Fort Lauderdale’s New River, in the next 90 days.

“The Fed news could help top tier developers get lower rates on construction. But not most,” Cymbal said. “Lenders will continue to be conservative.”

“Some prospective buyers who were ready to purchase may postpone their decision until rate cuts happen,” said Bilzin Sumberg partner Joe Hernandez.

 

Source: The Real Deal

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Amid its tinkering with the interest rate to tamp inflation down, the Fed has identified commercial real estate as one of the biggest risks to financial stability.

So where does that leave private lenders?

Mortgage Professional America reached out to Jeff Holzmann, COO of RREAF Holdings, to learn more. RREAF Holdings is a private real estate investment firm with more than $5 billion in assets.

But first some context: Large banks have pulled back from commercial real estate financing, causing smaller, regional banks to become more exposed to the travails of the industry. Given the freefall nature of the market, this creates a perfect storm for a “doom loop.”

And yet Holzmann seemed rather confident in his company’s approach to choppier waters.

“I think the obvious elephant in the room is the interest rate,” Holzmann said during a telephone interview. “Any large-scale commercial real estate developer like us is basically subject to the same metric. Some companies are bigger, smaller, but nobody has any type of silver bullet. We all do deals the same way.

But things are changed now.

“Obviously these days, the interest rates are what we would consider high,” Holzmann said. “Not necessarily historically high – if you had been around in the 80s and 90s, you remember higher rates – but they’re certainly higher than they were in 2015 through 2018. Pretty much everybody – unless they’re a liar or an idiot – is on hold right now.”

Living In An Age Of The Inverted Curve Yield

It’s a matter of economics.

Holzmann explined: “In terms of new acquisitions of income-producing properties such as multifamily, the main reason for that is simply because we are currently in what is known as an inverted curve yield – the cost of debt is higher than what you’re yielding from that property; your cap on costs is higher than your cap rate. Basically, you’re working for the bank. Any money you make on these properties – on average, there are always exceptions – is really going to the bank.”

So how does this movie end?

“It ends just like anything else in economics, in one of two ways,” Holzmann said. “Either through supply and demand. One thing that can happen is that interest rates – and I keep my fingers crossed, but keeping my hopes up – will decline; they will go back down, and there seems to be a consensus that this won’t happen quickly, and it won’t happen abruptly. So this is going to take a significant amount of time. The other thing that can happen in the next 12 to 18 months is that you’re going to see commercial real estate operators that basically can’t hold their properties. They’re running out of money, they’re crushed under the cost of the debt, and they are forced to sell.”

If it’s just a few properties succumbing in that way, some investor will swoop in and take it.

“But if you’re talking dozens, maybe 100s, every year, then that starts to change the economics a little bit and people might start selling at a lower price to avoid this kind of crash,” Holzmann said. “So eventually, I think the market will find equilibrium. But how is that going to come about? Through a change in the interest rate? Or a change in the supply and demand of vendors having to offload those assets? That I don’t know. But I do know that history teaches us that the market has to go back to some kind of equilibrium.”

Too Big To Want To Fail

Given today’s economic scenarios, there are strategies companies can adopt to mitigate risks and/or capitalize on opportunities. Holzmann outlined the way RREAF approaches things.

“RREAF is a large, institutional kind of operation,” Holzmann began. “We’re not like one of these younger entrepreneurs that can take crazy risks and make a killing. That’s not us. We’re a large business with a lot of investors and pension fund money, so we have to be very, very methodical about how we approach things.”

So what is RREAF’s approach?

“The way we approach it is by hedging the risk,” Holzmann said. “We prefer to be in a situation where we paid for a rate cap and regretted spending the money, as opposed to being in a situation where we took on the risk without a rate cap and now, in so many words, we’re screwed because we have to pay so much money in debt and this whole thing doesn’t make sense. Companies like RREAF don’t take that kind of risk.”

Formed in 2010, Dallas-based RREAF Holdings is a privately held commercial real estate firm that deals in the acquisition, development, asset management, ownership repositioning and financing of complex real estate projects throughout the US.

 

Source: MPA Magazine

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As with so many areas of real estate, there was an operational and profit high during the last few years that was like an industry getting drunk and then waking up with a headache.

Looking back can create regret, but here are some things that MSCI in its Q1 2023 U.S. Industrial Capital Trends Report suggests are easy to underestimate.

1. Immediate Comparisons Are Unrealistic

Would you compare a little kid running around with a blanket tied around the shoulders like a cape to an actual superhero? Of course not. Nor would you reasonably undergo a once-in-a-blue-moon experience and then expect that should become an everyday event. That is the difficulty in looking at typical year-over-year business comparisons in industrial.

“Industrial deal volume hit a record high of $40.6b for any first quarter in 2022,” MSCI wrote. “The next-highest first quarter period was in 2020 when $34.4b traded. Any comparisons of the current quarter to these record high points for the market are going to look harsh. In truth, the market simply slipped back closer to a normal level at the start of 2023.”

According to MSCI’s analysis, average first quarter deal volume from 2005 to 2019 is $11.2 billion. This year’s Q1 transaction volume fits in with the past.

2. The Industry Was Already Gearing Up For Higher Rates

“It can be difficult to think in terms of anything aside from Covid given the collective trauma experienced, but back in the fall of 2019, investors began to adapt to a rising rate environment,” the analysis said, remembering that concerns about rates existed before the pandemic.

CRE professionals attending industry conferences at the time were concerned about the Federal Reserve tightening its balance sheet. But it had been more than a decade since the Global Financial Crisis. Realistically, how long would the Fed put off cleaning its inflated balance sheet?

“Investors wanted to focus more on asset types that had low capex relative to the NOI for a rising interest rate environment, and the industrial sector matched this need.”

3. Investors Were Under-Allocated

The MSCI report suggests that investors hadn’t allocated enough of their capital to the industrial sector. This was true for multifamily, as they reported in a separate publication.

“It is not yet clear that investors have the allocations that they desire as there are many moving parts in place. But with the RCA CPPI for industrial slowing to only a 3.3% gain from a year earlier and volume back to average levels, one might make that case.”

4. Cap Rates Are Up, But Not That Much

One of the stories floating around is the return of cap rates. They are up some, but that’s in comparison to the depths they visited in 2022. Cap rates are nowhere nearly as high as pre-pandemic levels.

“The RCA Hedonic Series cap rate reached5.5% in Q1 2023, up from a low of 5.2% seen in Q1 2022 before interest rates surged. Cap rates have increased only 30 bps in a time when the 10yr UST has increased 170 bps.”

 

Source: GlobeSt

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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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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.

As many expected, the Federal Reserve recently decided to raise interest rates to the range of 1.5 percent to 1.75 percent, and the increases are likely to continue in 2018.

In March, the Federal Open Market Committee meeting announced its expectation for “further gradual increases” this year. Interest rates are extremely important in the evaluation and performance of any commercial real estate investment due to their impact on the present value of future cash flows. Higher rates make borrowing more expensive for owners, and tend to raise cap rates and reduce property values. However, higher rates also mean a stronger economy, which tends to be associated with a stronger real estate market.

So how will these increases affect commercial real estate investors? Alex Zylberglait, Marcus & Millichap’s senior managing director of investment, delves into how the increase in interest rates is impacting both foreign and domestic investment in U.S. real estate.

How will the rise in interest rates influence the commercial real estate market?

Zylberglait: The Federal Reserve recently raised interest rates by a quarter of a percentage point and is expected to raise rates twice more this year. As a broker who handles investment sales targeting properties in the range of $1 million to $20 million, which is the most active segment of the CRE market in South Florida, I can say that I haven’t seen much of an impact in the commercial real estate market yet. But having said that, I do anticipate a delayed effect, with rates influencing the market in the next three to six months. What I am beginning to see are prospective buyers locking in rates for long-term financing.

On the other hand, I am seeing more properties hitting the market, as property owners seek to cash out before cap rates go up as a result of rising interest rates. For example, one of my clients who owns an office building in Miami has a mortgage that’s maturing and debt coming due. Due to rising interest rates coupled with a maturing mortgage, my client wants to unload the property now instead of selling in a higher interest rate environment. But rising interest rates is one of many factors positioned to impact the CRE market this year.

How will higher interest rates impact foreign vs. domestic investment?

Zylberglait: The impact of rising interest rates will most likely be less on foreign investment than on domestic investment. The foreigners who use financing pay a much lower interest rate in the U.S. than in their home country.

However, what we’re seeing is foreigners unloading their CRE assets. For the past seven years, foreign investors have steadily moved away from buying pre-construction condos and turned their attention to CRE properties in Miami. As the Fed raises interest rates coupled with the real estate cycle nearing an end, foreigners are now cashing out for different reasons. Based on where we are in the real estate cycle, foreign investors are selling to capitalize on the rapid appreciation that the South Florida market experienced in the last five years. They no longer expect a significant appreciation so many of them have no reason to hold on to their properties.

Can you give an example?

Zylberglait: One of my clients from Argentina, who has been buying commercial properties in South Florida for nearly a decade, is now selling a single-tenant building occupied by Starbucks in one of Miami’s hottest markets, Doral. He recently renegotiated a nice lease deal with Starbucks to maximize sales proceeds in order to invest in value-add opportunities in the region.

Another one of my clients, Metro Capital Partners, which invests capital from Colombia in Miami, is another example of this trend. Metro recently sold an office building in Miami-Dade County’s West Kendall submarket for $7.9 million, after acquiring it in a 2014 distress sale for $3.2 million. For the most part, these investors are selling to either buy more assets in South Florida or pay down debt on other properties. Foreign investors continue to see our region as a safe place to grow and protect their capital even as interest rates continue rise.

What impact will the rate increase have on the South Florida market?

Zylberglait: In this real estate cycle, a significant amount of assets in South Florida were priced aggressively, with 2015 being the peak. As the market stabilizes or levels off, a rise in interest rates will contribute to faster stabilization of prices, resulting in investors preparing for slower growth and appreciation.

However, some of my clients who are more yield driven are looking outside of South Florida to places like Orlando and Tampa. We are starting to see a migration of investors and developers northward. For example, Dezer, a well-known developer in South Florida, recently purchased a shopping mall in Orlando with plans to redevelop it into an entertainment complex.

Another example is Riviera Point Development Group, a South Florida developer that purchased 3.3 acres on 11551 International Drive, a few miles from Seaworld, where he plans to build a dual-branded hotel, La Quinta Inns and Suites, and Tryp by Wyndham. Riviera Point developed five office buildings in South Florida and a Radisson Red Hotel near Miami International Airport in this real estate cycle. When it came time to purchase more land, Riviera Point’s CEO Rodrigo Azpurua chose Orlando because of land values and appreciation, which can mitigate the impact of rising interest rates. But having said that, I may add that land values in Orlando today are not as advantageous as they were a year ago.

How will the CRE market respond as interest rates continue to rise?

Zylberglait: Everyone knew rising interest rates were coming and as a result, we haven’t seen much of a reaction in the market. There’s no panic. However, the value for Class B and C assets is softening and I expect to see a divergence between Class A, B and C assets.

 

Source: Commercial Property Executive