It’s amazing how fast things have changed in the real estate market, just in the last few months. The government money distributed during Covid, along with interdependent energy policy and supply chain issues, has created an inflationary environment in a hurry.
To tame inflation, just like in the early 1980s, the Federal Reserve board has raised interest rates multiple times this year and is scheduled for more adjustments in the future. That has more than doubled interest rates for all types of real estate and lines of credit. The housing market has dropped off the table, and the number of home sales are half what they were a year ago. Inventory has more than doubled, and the price appreciation has slowed dramatically to less than 5%.
The multifamily market is more “normal” now, with vacancy rates in the 5% range. Rent growth has slowed dramatically to around 4% from over 20% in some projects.
There are still cash buyers for commercial real estate, as many people have sold their real estate elsewhere and still need to purchase something, and we are seeing lots of people moving to this area for its quality of life. They have cash reserves and with the stock market in disarray, they are using their cash to buy real estate.
Many of them are savvy, however, and know we are in a slower, more buyer-friendly market. This has created a dichotomy between sellers who still want a lot of money for their properties and buyers that know prices aren’t going up like they once did. It is the classic transitional scenario between a buyer’s market and a seller’s market in real estate. That said, there are still some properties still with multiple offers on them, because even some buyers view this latest cycle as a short blip.
The commercial real estate market lags the residential market in terms of cycles and trends. We are just starting to see signs of softening prices. This is a change from the high prices, and unprecedented, low first-year returns (or capitalization or CAP rates as they are called in our industry). Buyers anticipated and have seen increased rents in the past, especially in multifamily markets, so prices have been dramatically inflated for perceived continued rent growth.
I believe residential apart–ment complex prices will come down as savvy buyers study the statistics. An investor can get over 4% in a certificate of deposit right now, so cap rates for apartments need to be higher than this. Also, cap rates are below interest rates, and this “negative leverage” can’t continue. Annual debt service as a percentage of loan amounts needs to be lower than cap rates to maintain positive cash flow, as in the past. That means cap rates need to go up, or interest rates need to come down.
I don’t see interest rates ever being what they were in the last decade. It was an unprecedented time to buy commercial real estate. Even as I write this, the Fed has raised rates yet again, and the prime rate will go up another half point. Oddly, the one-year t-bill was down today, so we definitely have long-term rates lower than short-term rates. It’s a classic inverted yield curve, which can be a harbinger for a future recession.
We have sold land at huge prices for several years because of in-migration by individuals and companies. We still have some bidding wars going on over prime properties, and I’m constantly amazed at how much demand there still is in the commercial land market. Prices for existing buildings are strong also because it costs so much to build new and takes so much longer due to labor and supply chain issues.
Much of our commercial brokerage business is in leasing, and leasing is still active, especially in the industrial market. The office market is good in some locations and the retail market is good in some segments.
The restaurant industry seems to be active, and we have done many new quick-serve restaurant deals, with both site selection and leasing being active. It’s an interesting time for that sector, as no one wants to work, and food costs are high. On the one hand, many restaurants have shut down, but on the other, developers are still searching for quick-serve restaurant sites. To build a building for one of those tenants costs so much that rents need to be $50 to $60 per square foot. This is double what it used to be just five years ago, but companies such as Chipotle, Cafe Rio, Starbucks, Panda Express, and others are always looking for good sites.
This inflationary cycle will end, but I’m afraid it will take not months, but years, to work through as inflation is hard to tame. Look at the 1980s as an example. That was a tough time for our nation—and especially the Inland Northwest.
But as predicted many years ago, the quality of life in our area has driven people to move here, which might blunt the downturn this time around.
I would argue our quality of life is unparalleled. Where else can you pheasant hunt a half-hour from town and fish in one of 75 lakes within an hour? Where else can you go skiing at four great areas and play golf at world-class golf courses for $22? Our young people used to move to the coast because there was “nothing to do,” but now, the culture in Spokane is amazing. There is an emerging arts community among millennials that no one really knows about. In any given week, there are a multitude of concerts, plays, comedy shows, and other amazing cultural events. The restaurant scene is truly prolific and diverse.
For an area that was based on mining, agriculture, and timber, we have a great diversity in our economy now. Our health care industry is thriving, and we have an emerging aerospace manufacturing base, a good supply of venture capital, a great University District with two medical schools, and a number of startup companies that are worth millions of dollars.
I think the next generation will see the Spokane area change from a large, small town to a metropolitan area. Spokane will continue to be discovered because of its quality of life, increased technology (the ability to work anywhere), and great people. This will bode well for every facet of real estate moving forward.
One more factor must be addressed to continue to enjoy this quality of life and ensure outperforming other regions during tough economic times. In Spokane, we need to pay attention to our homeless, drug, and crime problems and get people off the streets and out of the cold. We need to follow the examples of Idaho, not the I-5 corridor.
This is important to our region and to commercial real estate. We need to work on housing solutions in all parts of our region and not just downtown.
That said, I am bullish on our region and will continue to encourage investment in real estate. And even if tough times are ahead, the old saying holds true: “There is no bad real estate. You just have to live long enough.”
Dave Black is the CEO of NAI Black commercial real estate brokerage.
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