On Wednesday, May 3rd the Fed’s Federal Open Market Committee (FOMC) decided to raise the benchmark Fed Funds Rate to a range of 5% to 5.25%, the twelfth straight hike to the highest rate we’ve seen since 2006.
It did not come as a surprise, as the Fed has been pretty transparent about its intentions lately. But, there’s more of a mystery over what the Fed will do next; pause to evaluate their progress to stomp out runaway inflation, or continue with rate hikes to make sure the fire is out. If the latter, many economists believe the result will be a recession, though nobody knows for sure. But we feel safe in saying that the cost of borrowing will remain elevated for the time being either way, and underwriting for new loans will likely tighten, especially in light of the recent regional banking crisis, which has brought commercial real estate back into the headlines.
To get a good feel for where mortgage rates for industrial buildings are heading, keep an eye on the 10-year US Treasury yield. They will run roughly 250 basis points above that level, give or take a few basis points either way. As of this writing, the SBA 504 rate (the most commonly used lending source for owner/user deals) is at 5.88% and the 10-year yield is at 3.40%. In the coming weeks, we’ll be watching that yield closely to see what impact the latest Fed rate hike is. If the 10-year yield stabilizes, we can expect mortgage rates to do the same.
That’s good news for property owners, as demand for good owner/user product is still running strong enough at current interest rate levels to prevent a significant decline in property values. In fact, supply of for-sale product is still quite thin, though available inventory for product offered for lease is rising and buildings are taking longer to lease up. Interestingly, pricing for both sale and lease product has held up surprisingly well to this point, though the number of active requirements has fallen, which indicates that prospective buyers and tenants are becoming more cautious.
That caution may be a reflection of slower overall economic activity. US GDP growth slowed to an annualized rate of just 1.1% in Q1, the second straight quarterly decline. And let’s not forget that we had consecutive quarters of negative GDP growth in Q4 of 2021 and Q1 of 2022. The latest GDP estimates indicate little to no economic growth for the rest of 2023. The good news is that the industrial sector is in much better health than office and retail, both of which are having a tough time recovering from the pandemic. Multi-family is also running strong, but rent growth in that sector appears to be topping out.
Inflation is still very much of an issue, though it has eased in recent months. The Personal Consumption Expenditures index (PCE), the Fed’s preferred inflation metric, is still running at more than twice the Fed’s target of 2%. The Consumer Price Index, which has been falling primarily because of the easing of fuel and used car prices, is down into the 5% range after surpassing 9% in the middle of last year. But, consumers are still feeling the pinch of higher prices at the grocery store and their favorite restaurants.
Where do we go from here? Our answer: we proceed with caution. The industrial market will remain in relatively good health, but the pace of activity will remain well below the crazy speeds we’ve been running at for the past decade. Good product will still get absorbed, but will take longer to move. Lesser quality buildings for sale and lease will probably move slower and downward pressure on pricing will increase.
What you should do depends on your unique circumstances. As we have been saying for the past year, those with near-term plans to sell should do so sooner rather than later, as the risk of recession that could send the market into correction territory is rising. If you are thinking about an acquisition, choose your new property wisely and plan on holding for the long term. This is not a time to be speculating on real estate. If you are an owner/user, make sure the building you buy supports maximum operational efficiency. If you can’t find one that does, choose from a growing inventory of properties offered for lease, and wait for the smoke to clear before buying. If you are an investor, buy quality, well-maintained property in a good location that has a good leasing history.
If you’d like to learn more about what is going on in your immediate area, please give us a call. We are here to help.