Determining the market value of your property is difficult these days. The good news for you is that it is probably worth more than you think because prices are moving up fast and in big chunks.
The traditional review of comps and current availabilities leaves even the most knowledgeable and experienced real estate professionals wondering just how any particular asset fits into the mix these days.
The underlying reasons for this conundrum are three-fold. First, lack of supply; second, low mortgage rates; and third, rising lease rates.
The industrial supply situation is both acute and chronic. It’s been a problem for years and it’s an even bigger problem today. Many thought the pandemic would loosen things up, but the opposite occurred. Orange County vacancy dropped even further over the past year and a half and it now hovers at just 2% countywide. In some cities it has fallen to less than 1% and is approaching zero for certain size ranges.
Coupled with unprecedented demand, it makes sense that prices keep moving up. However, the pressure is so great that the price spike is far from linear. A graph of the last year’s comps looks more like a staircase than a ramp, and that makes it more difficult to peg a value to any particular asset with traditional market metrics. This is why we often quote a range of value to our clients and in some cases offer a property for sale without an asking price. In either case, multiple offers are on the table in a matter of days. More often than not they exceed our clients’ expectations (and ours, as well).
When you add record-low mortgage rates to the mix, things really get interesting. Right now, the SBA 504 rate for a fully-amortized, 25-year 2nd mortgage is just 2.81%. When that loan is combined with a conventional 1st mortgage, the blended rate for a 90% loan-to-value package is available in the low 3% range. So, a tenant paying a record-high lease rate with 3% to 4% annual increases can fix his occupancy cost for 300 months as long as he has 10% of the purchase price in hand for a down payment.
Thus, even at today’s prices, it makes sense to buy, especially given the fact that there is no new inventory being constructed or in the planning stages. Land for ground-up development, whether it be for sale or lease product, is just too scarce and expensive. That leaves only existing inventory, most of it built before 1990, to choose from. From our perspective, only a significant economic event that shocks the demand side could change the current dynamic. Absent that, prices should continue to rise. Those who don’t anticipate such a change keep holding on to their properties, which further restricts the flow of supply. The few who do are cashing out with a huge profit and throwing a lifeline to those willing to pay a price premium to fix their occupancy costs.
That brings us to the lease rate issue. In Q2, the average asking lease rate in Orange County rose another $.05 to a new record high of $1.12 on a net basis. Tenants desperate for space are locked in fierce competition to get the attention of landlords who essentially hold all the cards in lease negotiations. Free rent and tenant improvements allowances have dwindled and landlords are holding out for good credit tenants and demanding hefty security deposits and personal guarantees. To say the least, this is a good time to be a landlord and why many tenants have decided that building ownership is the way to go. That has further exacerbated the imbalance between supply and demand for purchase opportunities.
If your investment strategy is long-term enough to hold through an economic downturn, it may be a smart one. However, if your current plan is to exit your property investment in the next few years, it may be wise to adopt a sooner-rather-than later approach. The American Families Plan moving through Congress right now contains proposed tax hikes on capital gains, severe limitations on 1031 exchanges and taxing capital gains at death, which would essentially eliminate the step-up rule, a popular estate planning strategy. Alone or in combination, these changes to the tax code could be the potential economic shock we refer to in this post. Click here to read our series on the topic. We don’t know what the final legislation will look like or if it will even make it to the President’s desk to sign into law, but it has been looking more likely in recent weeks.
If your plan is to sell in the next 5 years, the sooner-rather-than-later path may be your best option. We are in conversations with multiple clients every day who are contemplating just that. The first step is to get an estimate of your property’s value. We can help you with that and you’ll be pleased with the numbers we give you. Then speak to your financial advisors to determine the tax and estate planning impact of a sale. With those facts in hand, you can then weigh the risks of staying with the status quo versus taking near-term action. We will do everything we can to help you through the process. Just give us a call to get started.