THE AMERICAN ECONOMY HAS PROVEN RESILIENT BUT COMMERCIAL INVESTORS ARE IN TROUBLE
By most metrics, the U.S. economy has proven much more resilient (so far) in the post-Covid era. Inflation has spiked around the developed world and the Federal Reserve has aggressively increased interest rates, much to the chagrin of real estate investors. As we’ve discussed extensively, it’s not a good time to buy rental property and these government measures are the largest piece of that puzzle. But overall, the economy has withstood the transition out of the heavy spending period, markets are stable, and domestic inflation is much better than expected. So while many of us are able to take a deep breath and patiently wait to see when the real estate market will turn for the better, those who own commercial office space are likely fearful of what’s to come next.
THE LEFT-RIGHT KNOCKOUT COMBO ON THE CHIN OF OFFICE BUILDING OWNERS
First off, not many of us can afford to own large office buildings, but we do have plenty of clients who dabble in smaller commercial office space. While the problem outlined here is most serious for those who have the most skin in the game, the general themes are universal when it comes to office space holdings. For these commercial investors there are two major issues on the horizon: decreases in revenue due to remote work and increases in costs due to the aforementioned interest rate hikes.
By some estimates, American offices are still about half-empty as remote work proves especially sticky post-Covid. Many companies are urging workers to return and the debate over what is most beneficial to workers and companies is beginning to heat up. Nonetheless, recent trends suggest that the office environment will never return to pre-Covid expectations. Worker flexibility can often be leveraged to improve efficiency and when that is the case, companies can decrease their footprint; or in other words, reduce the amount of office space needed. With Nexus teams in Phoenix, Providence, New Haven, Worcester, and the Greater Boston area, we see the reality of this change play out daily. For landlords, this means less demand, and less demand means decreased value to go along with decreasing rent collection. With values and returns plummeting, office owners don’t have a viable escape plan.
With less money in hand, and less equity in their properties, commercial owners also have to deal with the same interest rates that have slowed down the residential market. These interest rates are now at the highest level in 22 years and there’s debate over whether or not the Fed is done. For many of us on the residential side, we may have taken advantage of historically low rates from five years ago and are more or less insulated from the more recent hikes. For commercial real estate, the same insulation does not exist. Those mortgages are up for renewal every five years and do not have fixed rates for the term of the loan. Just like residential investors, a larger number of these property owners refinanced when rates were at their lowest…and now those five year resets are here. As Nexus’ Vice President of Franchise Sales, Greg Rice, illustrated recently, the jump from 2% to 6.5 or 7% changes the math completely and makes many properties unaffordable.
As The Washington Post’s Catherine Rampell explains, a lot of commercial real estate is struggling with higher borrowing costs and that is compounding with the trend in work from home and geographic trends. Providence Business News’ Sam Wood goes even further in predicting that this issue could have a heavy impact on the American economy.
INVESTING IN RESIDENTIAL PROPERTY IS STILL RECESSION-PROOF
All markets are cyclical but not all assets respond to market fluctuations equally. While the residential real estate market is not overly attractive to investors right now, it is still stable and the majority of our clients, who own 3 and 4 family apartments, are still pulling in the passive income they signed up for, provided they bought before the interest rate hikes. As discussed, the demand for office space has dropped precipitously, but the demand for housing will always be there and this reality buoys rentals as the best investment strategy in terms of risk and reward.
Nexus Property Management® strongly recommends that you stay away from riskier commercial investments. Real estate investment is a long term game and with commercial it’s just a matter of time before a variable beyond your control puts its thumb on the scale and you find yourself in a losing position. Rental properties are a safe place to start and a safe place to continue to invest, especially with a professional property management company in your corner.
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Mick Lefort is the Owner / General Manager of Nexus' New Haven County Franchise Office and the Vice President of Operations for Nexus Property Management®. A National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.
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