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!
Last week the Housing Price Index came out with the 3rd quarter housing appreciation numbers. The great news is that Sacramento real estate has appreciated in value 56.9% over the past 5 years. Do you realize that represents an average growth rate of 11.38% per year over the past 5 years? So, if you bought real estate in the Sacramento MSA in 2002 or before, you made a great investment.
Of course that’s only part of the story. As you read in Found In Translation, Sacramento real estate has been continually dropping in value since the market peak of the 3rd quarter of 2005. So, if you bought in 2005, you bought at the top of the market and your property is likely worth less now than when you bought it.
For Sacramento commercial real estate, particularly retail properties, this does not bode well for property values. The old adage that “retail follows rooftops” is true. In 2003–2005, throughout Sacramento you saw a glut of new homes going up. In Elk Grove, Roseville, Folsom and Natomas, new retail was everywhere because that is where most of the homebuilding was occurring.
Those areas were able to charge increasingly higher rents for retail space because of the demographics of the people moving into those areas. Because the value of a retail property is in its leases, that made the value of retail inordinately high. As a result, many property owners noticing the high values were selling in an effort to lock in these uncharacteristicly high profits.
This increase in value did not just affect new retail properties. Owners of older centers also saw an opportunity to raise rents as leases came up for renewal and/or spaces became vacant. While its true they couldn’t charge the same amount that the new center owners could charge, they could charge more than they had in the past due to simple supply and demand.
Then the appreciation market shifted to a depreciation market in Sacramento. Now homes were rapidly depreciating and many people lost their source of cash. How’s that? Unfortunately, many homeowners recognized that their homes were appreciating rapidly and they used re-financing as a tool to continually take cash out of their homes. With the cash, they started new businesses, bought new toys, etc.
Now that the “cash flow” of appreciation is not there for the consumer, shopping has slowed and many retail businesses are failing. The percentage of rent that a retailer pays as compared to their now reduced income is simply too high for many of them. As their businesses fail, retailers leave their stores and the accompanying leases behind.
Since “retail follows rooftops”, retail properties have also lost value. During the Christmas season, pay attention to what the media is saying about retail spending. What you will see is the increasing percentage of internet sales. When money is tight, consumers have to choose where they can get the most bang for their buck. As people buy more online, they buy less in stores.
This is not to suggest that shopping in stores is dead. It is not. However, the face of shopping is changing and keeping abreast of those changes will make the difference in the profit you get from your retail real estate investment.
This change in the market it just one part of the value of commercial real estate. As you read in Creating Certainty With Real Estate, there are 3 markets that can affect the value of your property. We are only addressing the space market here. Sign up at Smith Real Estate Services to receive future information on the remaining 2 markets, namely the capital market and the property value market.
When does 3 = 1? The answer is in commercial real estate. When looking at the commercial real estate market, we must actually look at 3 different markets.
I. The space market:
This is the physical space that exists in the market. The measure of the space market generally comes in the form of absorption rates. In the space market, the goal is to predict the future by looking at supply and demand in an area. This is never more critical than in retail properties. As there are more people in an area, more retail is required. As people migrate away from an area, retail will die. As current and future retail property owners and developers, absorption rates are critical as is looking at the migration of the population in a geographic area.
II. The capital market:
As much as you love real estate, it is only one of several places where you can invest your money. Stocks, gold and bonds are examples of other places where you can invest. To determine where to invest your money, you will generally compare the rate of return you can get from alternative investments. Once you set your desired rate of return, you can then evaluate which investment is the best vehicle to get you there.
III. The property value market:
This is the market where cap rates come into play. Any change in the income or expense of the investment will change the cap rate, because the cap rate is only a “snap shot in time”. However, as savvy investors know, you make your money in an investment 2 ways: 1. Buy it right and 2. Control expenses. These are both functions of the property value market. In addition to operating expenses, you will also want to stay aware of legislative and tax law changes.
In order to be successful with your commercial real estate investment, you must be aware of all 3 markets. When you are, you will begin to see when it is time to make your move, either into or out of a market and/or investment.
Working with a qualified professional is an important part of your process. You need to choose wisely as there are very few professionals who are well versed in all 3 markets. After all, you can make a deal by considering just 1 of the markets, like say the property value market (ie: cap rates). However, the question becomes, do you want to make a deal or do you want to make a great investment?
When you choosing to buy Sacramento commercial real estate, hire a professional with the CCIM designation and put their expertise on your side. This knowledge will give you the foundation that will help give you certainty when investing in commercial real estate.
The 2nd Annual Sacramento Strip Mall Conference was held this week. The conference was full of ways for retail property owners to make money. As your retail real estate expert, I will share a few of them.
1. Charge for your monument signage. Make the fee agreement an addendum to the lease. This gives you additional revenue, which increases the value of your real estate. It gives the tenant a way to advertise their business to every car and person that passes the site.
2. Monitor your tenants sales volume monthly. If you begin to see a trend emerge, as the property owner, you can step in to assist rather than wait until the tenant goes out of business. This right should be included in your lease.
3. Use your strip mall for fundraisers. This is a wonderful addition to the community. Since the residents are the ones who frequent your centers, give something back.
4. Charge for an exclusive from a small user. In some areas, there are many vacancies. If the tenant is desirable and brings value to the center, you may opt to give them an exclusive when they pay a higher lease rate.
5. Green construction will soon be mandatory. As you make improvements to your center, consider green construction. You will be ahead of the curve and bring value to your center.
6. Right now, there is a battle called mega grocery, cheap price vs. high experience, high price. As a result, some of the largest grocery chains find themselves in the dreaded “middle”. To address the consumer need, many grocers are renovating their stores. If these chains are your tenants, be aware that once the renovations are complete, property owners are realizing significantly increased rents from those tenants at lease renewal.
7. Be cautious with new construction. Tenant driven retail is preferred over spec retail. Know who the retailers are that are looking to expand in your area and get into relationship with them.
8. There are 2 new categories in the “Structure of the Retail Market”. They are “big box” at the top of the model (that is bigger than malls) and “convenience retail” at the bottom of the model. As our residential dwellings shift from single family homes to multi family (which includes high end condos), so does the need for retail. The convenience retail category will become the giant of the future.
9. If you are developing, know the process. it will go a long way toward getting your plan approved. Skipping a step in the process can really cost you.
10. The fundamentals in the Sacramento commercial real estate market are very good. Cap rates are increasing interest rates are still low. Some property owners are in trouble due to the shift in the market. This combination makes Sacramento real estate a great “buyers” market for the savvy investor. Work with an investment real estate broker who offers information, education and communication so you can capitalize on the “deals” that are available in today’s market.
You own commercial real estate. This property is likely one of the highest performing assets you own. When you have a problem with it, you call an agent/broker to assist. Who ya gonna call?
If you need to have space leased, your needs will best be served by someone experienced in your property type. An agent who has experience with retail is not necessarily familiar with an office or industrial lease. The provisions in each area of specialty are different. Make sure your agent has experience in your property type.
When you need to sell your property, you need an agent who understands there is a difference between an investment property and an owner user property. Owner user properties are generally a little higher priced and require a very specific owner. The investment property is all about the cash flow and the net operating income. Any investor could have an interest in an investment property.
Keep in mind that commercial real estate is a very broad category. The basic categories are land, office, retail, industrial, multi-family and hotels. Whether you need a leasing agent or a selling agent, experience in the property type you own is critical.
In addition to the specialty knowledge, an investment property also requires a thorough knowledge of financial analysis. The really good agents/brokers can not only do the analysis but also explain it to you so that you understand the numbers as well. When you see the CCIM designation after someone’s name, you know they are among the best in the world at financial analysis.
While you may be inclined to use the residential agent you’ve used many times before and trust, be careful here. You wouldn’t trust your general medical doctor to perform open heart surgery would you? The same consideration should be made for one of your highest performing assets, shouldn’t it?
Yes, I am referring to Apple Computer Stock. We have friends who bought 100 shares for $19.95 each. They are a great example of someone who bought low and sold high in the stock market.
What is easy to overlook here is that 20 or so years ago when this purchase occurred, they were very strapped for cash and really had to suffer to buy the 100 shares.
We have a similar situation with real estate. The owners of commercial real estate who bought before the recent increases generally had to scrape their money together to buy the property. They had to do without in the hopes of buying low & selling high. It paid off for them if they sold in the last 2 years or so because of the escalating real estate prices.
If these owners choose to sell their real estate today, they will still experience extremely high returns due to the appreciation of the property. Now the bigger concern for them is the tax consequence. The good news is that this is an area that can be controlled in a number of different ways, many of which I will be talking about in future posts.
What is happening now is that investors are looking to lock in their future returns on properties by buying low and selling high. In order to do this, they will realistically need to buy:
- properties in bad neighborhoods that are experiencing redevelopment
- properties with high vacancy rates
- properties with deferred maintenance issues
In a word, properties with problems. Buyers might stumble into someone who will give the property away for less than the value but those deals are few and far between. Today’s owner is more savvy than in years past and they often have a feel for what they think the property is worth.
Since prices have generally dropped for commercial properties due to the interest rate increase and the return to negative leverage (among other things), you should buy commercial real estate now. Obviously, to actually own the real estate, you need to be realistic in your expectations, don’t you?
Otherwise you may wish you’d bought AAPL at $19.95 rather than $135+ per share. Whether its the stock market, real estate or life, timing is everything.
Are you waiting for the bottom of the market to buy more real estate? Whether it’s the stock market or real estate, people try to buy low & sell high. Very few people get the timing just right. But by waiting for the perfect time, most people miss the opportunity to build wealth altogether.
Think about annual appreciation rates for residential real estate in Sacramento. In the past 7 years there have been 4 perfect times to buy. That was Q1 of 2000, Q2 of 2002, Q3 of 2003 and Q1 of 2004. In all 4 of these quarters, appreciation rates had dropped to a low point. If you were only willing to buy at the lowest point in the cycle, those were the times.
However, for all of 2000 and from Q4 of 2001 to Q1 of 2004, the appreciation rates were all less than 15%. The top of the market was 26.58%. Think about that. You had over a 3 year term to buy and get a minimum gain of 12.25% annually in appreciation. Or, you could have set it out because you missed those 4 specific quarters.
When residential real estate is appreciating, rents are generally increasing in commercial real estate. Since the value of a commercial investment property is in the rents, this means a solid residential market affects the value of commercial real estate in a positive way.
Do you have money earning you a low rate of return in mutual funds or a bank account? Consider taking advantage of this fabulous buyers market and buy commercial real estate. If you choose to take action now, you can capture some of the lowest prices in over 5 years and experience all time lows in interest rates. This combination will not stay around forever.
As your local real estate professionals in Sacramento, CA and Boise, ID contact us… we can and want to help you build wealth through real estate.
If you have been thinking about investing in commercial real estate, call 800–613–9852, ext. 402 to get your copy of our FREE report on How to Buy Commercial Real Estate…the Easy Way.
The Sacramento landscape is changing. Are you keeping up with the changes? Take this quick quiz to see how well you know the new “Sacramento”.
If you are from outside of Sacramento, you may consider all of the towns listed “Sacramento”. However, the numbers show some separate and distinct characteristics of each area. This information is critical for you to know when deciding on where you will buy real estate.
1. Which area has the highest growth rate from 2007 – 2012?
A. Folsom
B. Roseville
C. Elk Grove
D. W. Sacramento
2. Which area has the highest 2007 Average Household Income?
A. Roseville
B. Elk Grove
C. Folsom
D. Fair Oaks
3. Which area has the highest unemployment rate?
A. Sacramento City
B. W. Sacramento
C. Rancho Cordova
D. Arden-Arcade CDP
4. Which area has the highest percentage of owner occupied homes?
A. Folsom
B. Elk Grove
C. Roseville
D. Fair Oaks
Depending on your demographic preferences, you may choose one area over another. For more detailed information on a specific location, contact us.
Demographics are a start to making an informed decision about your new location. Making informed decisions is how you will build wealth thru real estate. Whether it’s commercial, residential or investment real estate, let Smith & Associates show you the way that best meets your requirements.
Answers: 1. B; 2. C; 3. C; 4. B
