Investors’ desire for commercial real estate has soared throughout the pandemic. But rising interest rates? That could slow commercial deals.
We spoke to two commercial finance experts with the Columbus, Ohio, office of Bellwether Enterprise, Sam Miller and Conor Lee, both vice presidents, about what they expect now that the Fed has once again raised its benchmark interest rate.
Here is some of what they had to say.
How has the Fed’s latest hike in its benchmark interest rate impacted demand for commercial financing?
Sam Miller: Obviously, the Fed is going to continue to raise its rate. The Fed made it clear that its target is to get the benchmark rate to 4.6%. This is happening in real time right now, so everyone is feeling it. The rising rates are definitely slowing things down. The higher rates are making deals more challenging to close.
The saving grace for a lot of folks, especially in multifamily, is that rent growth has continued, too. That helps to absorb some of the shock from rising interest rates. The reality is that there is still a massive shortage of housing. There is a lot of demand for housing. And because of that, the demand for multifamily is growing, too, which means that owners can still grow their rents. That is helping to blunt some of the impact from interest rates.
Conor Lee: From a real estate perspective, supply and demand is still in great shape. There is a ton of demand for housing in general. The number of units being developed is not fulfilling that demand. Are there potential layoffs and a recession ahead of us? If so, we might see bad debt creep into collections. We might start seeing occupancy issues. People who are looking for one-bedroom apartments might start looking for two-bedrooms so that they can bunk up with roommates to lower their monthly costs.
Right now, we are still seeing multifamily assets performing well. But what does your capital stack look like? If you have a refinance event, if you have a certain debt load you are at, can you get out of that debt? Can you return equity to your investors? That is challenging when rates are high.
Sam Miller, Senior Vice President, Bellwether Enterprise
Does it look like multifamily is resilient enough to remain a good investment even during times of higher rates?
Miller: From a housing-market perspective, in some ways we are fortunate that it has been hard to build single-family housing for the last 10 years. When you look at the supply and what the vacant inventory was going into the great financial crisis of 2008 and 2009, it was so much more than it is today. There is not a huge glut of supply sitting there. Most people who own homes are possibly financed at 3.5% or lower. People don’t have to move now. If they don’t have to move, they won’t move. Why trade your 3.5% mortgage for a 6% mortgage? That further makes the case for multifamily. There are going to be more homes that don’t go on the market. That will increase demand for apartment units.
Are you seeing more multifamily supply coming on the market to help meet the high demand for it?
Lee: This is in flux right now. We are already seeing in Columbus developers pulling the plug on or pausing projects. That started because of the rising construction costs. Now with interest rates going up, that pause is going to continue. Couple construction costs with the cost of debt, that makes it more challenging to build anything. Construction lenders are starting to pull back. Underwriting metrics are more challenging. This environment is making it more difficult to get projects out of the ground.
Conor Lee, Senior Vice President, Bellwether Enterprise
I’ve asked others in the industry this, but even these rising rates are at historic low levels. Is there any acknowledgement of that in the commercial business?
Miller: We have been a little bit of doom-and-gloom here. At the end of the day, though, what is causing a lot of the pain right now is the uncertainty. A 3.75% 10-year treasury is not the end of the world. But expectations need time to reset. If we start to level off and find a place where the Fed stops raising rates and lets things take their natural course, I think everyone will feel better. Everyone will have to adjust, but they will do that. It’s just been a big change in a short period. I’m hopeful we will come out of it with a soft landing. It’s just difficult right now to know where the dominoes will fall.
Lee: Our strategy right now is to keep moving. We are trying to find ways to do deals. There is still a ton of capital out there. There are still a lot of debt providers in the market. As long as capital is still available, people will figure out how to do deals. If capital goes away, then we have a bigger problem.
We’ve talked a lot about multifamily. But how attractive of an investment is industrial real estate right now?
Miller: Industrial has a lot going for it. There is a massive need for more industrial product. From a development standpoint, though, industrial is a little trickier than multifamily. You might have one to three tenants in a typical industrial building. You are entering into long-term leases of five, seven or 10 years with these tenants. The challenge you’ve seen recently is with the increase in costs, both from construction costs that are rising and rising interest rates. You might agree to a 10-year lease with FedEx. You might have agreed to that lease in July, but you’re not able to build until October or November. Suddenly, you’re costs are up 10% because interest rates have gone up. Everything changes so fast now. That million dollars of profit that you were counting on as a builder might now be gone.
But from a fundamentals standpoint, there is still room for rent growth in industrial. The mechanics of getting deals built is changing. Everybody is going through that, but we are seeing it more in industrial.
What are you seeing right now in terms of deal velocity?
Lee: It is definitely slowing down. Things will slow. Velocity will slow. I don’t see how it doesn’t. But as long as capital is available, the market finds itself. We just need calmness. We can’t operate in this day-to-day volatile market. It’s hard to give guidance when things change so quickly.