Last Tuesday, the buzz about the .75% cut in the Fed’s rate (also called the prime) started. People got on the phone to their mortgage lenders asking if now the time to refinance their home loan is. As a result, there is a lot of information about what that rate cut means to residential loans. However, I’ve seen nothing about what the cut in the prime means to commercial loans, especially not in simple terms.
So, I asked Dan Conrad of Smith Craine Finance the question and he answered me very simply and concisely. Here is the answer.
The Fed’s cut doesn’t mean much to commercial loans because most commercial loans are fixed rate loans. The only people who may be affected are those with adjustable loans that are coming up for negotiation in the 6–12 months.
The thing is that when those loans come up for negotiation, many of these commercial borrowers will expect their rate to go down because of the “Feds” cut. In reality, there was actually a spike up in interest rates yesterday, so it does not follow that a cut in the prime causes interest rates to go down.
If you want to see a better correlation for interest rates, look to the bond market because mortgages are packaged together with other loans and sold on the secondary market which is the bond market. So, in very basic terms, the bond market determines the interest rate.
The next question is obvious, namely, What makes the bond market rates fluctuate? Simply, disasters. The more disasters there are, the lower mortgages should go.
Now, there is a distant relationship between the prime and the bond market. The bond market trails the prime typically by 6 months or more. That’s why commercial borrowers with a commercial loan coming up for negotiation within the next 6–12 months could feel a result of this cut in the prime.
What does this mean to an investor? The usual. When you find a deal that meets your objectives, work with a qualified investment real estate broker and buy it. Use the tools that a professional like me can provide to help insure that your next real estate investment is a good one.
You had a vacancy in your center and after a few months, you finally have a new tenant. Hurray!…or is it?
As with all of real estate, it depends. Let’s look at what that new lease might do to the value of your shopping center.
I. Local or National: If you signed a local tenant, that means you’ve said no to a national one, in practice. Investors generally prefer the stability of a national or regional tenant, so when there is a choice, go national.
II. Market Rent: Your agent has shared with you what market rents are but no one has agreed to pay your rent so you accepted less rent to lease the space. Let’s look at one scenario of how this might affect you.
Assumptions: Market Rent is $2.00 per square foot (psf) net net net (nnn). Vacant space is 2,000sf. Lease term is 3 years. Actual NOI is $349,400.
If you accept a tenant at $1.90psf nnn, that adds $45,600 to the equation making the actual net operating income (NOI) $395,000. If you cap the NOI at 6.5%, you would have an asking price of $6,076,923.
If on the other hand you had a vacancy showing $2.00psf nnn, that would add $48,000 to the equation making the Proforma NOI $397,400. When you cap that NOI at 6.5%, you would have an asking price of $6,113,846.
That’s a difference of $36,923 potentially coming out of your pocket just because your tenant is paying $0.10 below market rent. Remember, a vacancy can be considered a positive if: A. Your bottom line can take the hit; B. If the buyer has tenants who could fill the space under his management; and C. If you plan to hold the center past the term of this new lease.
III. Tenant Mix: Let’s look at another scenario which illustrates how the tenant mix could affect your shopping center’s value.
Assumptions: 20,000 sf center. 4,000 sf are vacant. Tenants: Nail salon, insurance agent, restaurant, mailbox store, bookstore, spa and karate studio.
You elect to sign a dry cleaning plant to fill the space. Prior to this tenant, there were no environmental concerns with your property. With this new tenant, any buyer who needs a loan to buy your property will have to pay for both a Phase I and a Phase II to confirm that the ground is environmentally sound. If problems are found, they must be remedied prior to the loan funding. Additionally, as the owner, you will have some additional environmental guidelines that must be met while you own the property as well as some potential liability.
Clearly, this increases the buyer’s due diligence cost but more importantly it raises questions as to lifelong responsibility for the affected land. These questions can directly translate to a reduced value of your shopping center.
When you consider the type of tenant, the market rent and the tenant mix, it is critical that you keep in mind your long term goals. If you plan to sell within the next 3 years, consult with an investment professional now.
These examples are very basic and not intended to be exhaustive in nature. To have more specific information about your property, Smith Real Estate Services, Inc. is a great place to start.
It simply makes good sense to work with an agent/broker who has your long term goals in mind, not just one who wants to earn a quick commission. When you work with an investment professional, you will have access to all the value they can bring to you. This value runs through the decisions you make during your holding period as well as when you sell your center. Choose your agent wisely.
Real estate fortunes are made by people who buy low and sell high. The question is, how do you know when it’s low?
You would have to be under a rock to miss that our economy is having challenges. Listen, anytime the government even thinks about giving the people money rather than collecting it in taxes, you know we are in trouble. So, what are you going to do about your chance to build wealth right now?
Real estate is a long term investment. Consequently, you have to get in at the right time and at the right price and in the right location. There are 3 primary factors to look at when considering if you should invest in a particular location, especially with commercial real estate.
1. What is the economy doing? In a bad economy, there are deals to be had. This is the classic time to buy low.
2. What is the population doing in the area that you want to buy? If it is going up and it is expected to continue that upward growth for at least 5 years, that’s a good sign. Why 5 years? Because you want the real estate to perform well while you own it AND when you want to sell it. If your timing is off, you may try to sell when a neighborhood is in transition or when it is a buyer’s market. Right now you want a buyer’s market because deals are available. However, when you sell, you want a seller’s market in order to maximize your return.
3. What is the employment like in the area of your acquisition? If jobs are strong, that bodes well for your asset. There are actually 2 job types to be aware of.
Basic jobs are jobs that feed the local economy and bring in revenue. For example, a manafacturing plant in California makes more than enough widgets for California. They ship the widgets all over the world so the revenue for the widgets comes back to California. As a result, that plant creates jobs and revenue.
Non-basic jobs are jobs that simply circulate the money that is already there. Retail, banking and services are all good examples of non-basic jobs.
You want to own real estate in an area than has a high percentage of basic jobs because that means that local economy is strong.
The time is right to buy commercial real estate. Yes, it may drop further but interest rates may rise and the sky may fall according to Chicken Little. So, when you find a piece of commercial real estate that meets your objectives, buy it.
The right real estate professional has all the tools you need to help you make the right decision and put you on the path to building wealth through real estate. Choose wisely because you work hard for your money!
