Commercial real estate is one of those sectors that has always performed well. This is regardless of how the economy is. But we're now seeing a decline in commercial property prices. Which is shocking. There's an almost 5% decrease since the second quarter. The biggest reason behind this decline has been rising interest rates.
Globally, commercial real estate is experiencing yet another unfavorable downturn.. The outlook, however, differs from both of the earlier catastrophes. The slump of today is primarily a pricing issue.
Debt is still a possibility. There is speculation of investment mortgage rates rising by 300 basis points in just a few months, which would double payments, so it is undeniably less free than it once was and undoubtedly more expensive.
However, rent is still being paid by tenants. Rents are rising in many residences while arrears are at historically low levels.
Yes, both of those indicators are subject to change. Tenants would face pressure during a recession, but bond rates would decline in that scenario, as they have in recent weeks as a result of recession fears.
Climbing interest rates have never been friendly with real estate. The post-pandemic and European war effects have brought this on. The Feds will raise rates further - almost 75 basis points by next year. These constant hikes have broken investor confidence. Thus, demand is down. The market slowdown during the pandemic caused there to be an abundant supply. With supply and demand in disequilibrium, prices are falling.
6 Reasons Why Commercial Property Value Is Going Down
1. Rising Interest Rate
The increase and decrease of interest rates, or the cost of borrowing money, can have a significant impact on commercial real estate. The majority of commercial properties are funded, constructed, and then leased. When financing or refinancing commercial real estate is costly, fewer borrowers enter the market, which can result in a decline in property prices.
In addition to discouraging corporate investment and expansion, high-interest rates result in commercial real estate vacancies that lower market prices.
2. Government Policies
All levels of government policy can have an impact on the commercial real estate market. For instance, a government per-transaction tax on tanning salons could drive certain salons to raise costs, thus reducing revenue and resulting in salon closures.
For example, government waste disposal rules may increase the cost of doing business, which must be allocated elsewhere. Businesses that are negatively impacted by government regulations may close, resulting in property vacancies and market value declines for commercial real estate.
3. Maturing Debt
Debt can be a good thing sometimes in real estate. However, this can also cause a downfall in the overall market. Derek Bruce from SkillsTrainingGroup says "Commercial debt incurred over the last decade's real estate boom is now ageing and will become payable this year. Not all of these borrowers will be able to refinance or pay off the balloon payments."
He also added that "this could provide a chance for investors to fund those borrowers who fall short because commercial bank funding is becoming increasingly difficult to get."
4. Stressor Lending Rules
Regulations governing commercial mortgage-backed securities have changed, raising the cost of borrowing for landlords. This lowers cap rates and, as a result, limits future price rises. In secondary and tertiary markets, where landlords rely on Wall Street banks for funding, this is particularly true for real estate. It has to do with liquidity.
The cost for Wall Street banks to hold those securities increased due to new Dodd-Frank restrictions. According to research, debt prices crashed in February as a result of hedge funds being obliged to sell their CMBS holdings due to increased worldwide unrest.
It's also possible that the selloff had little to do with the fundamentals of real estate and instead "highlighted an increasingly important headwind" to commercial real estate from the debt market.
5. Bad Economic Conditions
If broad economic circumstances are bad, low-interest rates will not aid commercial real estate. For instance, when unemployment is high, the market value of some types of real estate may drop. However, various forms of commercial real estate respond differently to weak economies.
Also, the hospitality industry's real estate suffers in sluggish economies when consumers reduce or forego hotel stays.
However, Megan Arkis from ICRFQ believe that "Office buildings and other commercial assets that provide long-term leases may not experience vacancy increases as a result of these agreements."
6. Oversupply Of Commercial Properties
The current recession has led to many businesses shutting down, meaning there are fewer businesses requiring commercial space. The rise of online shopping has also contributed to the decline in demand for commercial space, as more businesses move to an online-only model.
The value of commercial real estate has a direct impact on the economy. When commercial property values decline, businesses suffer and this can lead to job losses.
A decrease in commercial property values can also lead to foreclosures, as businesses are unable to keep up with mortgage payments. This can have a ripple effect on the economy, as foreclosures can lead to a decline in consumer spending and an increase in borrowing costs.
There is not much that can be done to stop the decline in commercial property values, as it is largely driven by economic factors. The best we can do is now hope for the economy to recover which will automatically drive up the value of these commercial properties.