As we suspected would be the case, the interest rate on the popular SBA 504 mortgage fell sharply for the second straight month.
On January 8th, another 36 basis point decline was announced, bringing this key rate down to 6.36%. Just two months ago, it was 7.01%. This is great news for both buyers and sellers of industrial buildings in Southern California, and could be a catalyst for an increase in both the demand for and the supply of this popular real estate product. Let’s take a closer look.
The veracity of the owner/user scenario is highly dependent on the availability of affordable mortgage funding, and the SBA has been the primary provider of loans to business owners acquiring property for their own use for decades. The SBA 504 program allows the owner to invest just 10% of the purchase price to acquire property. In a typical SBA loan scenario, a conventional lender makes a first mortgage of 50% of the purchase price while the SBA provides a 40% second mortgage from funds raised through bond issuances. Both loans are at fixed rates for 25 years. The conventional lenders are eager to offer good terms on these low risk loans, as their loan-to-value ratio is low and the owner/user sector has a strong performance record since the mid-1970’s.
With such high levels of leverage associated with SBA-funded transactions, the interest rate on both loans has a profound impact on monthly payments. So, even a moderate increase in interest rates can throw a wet blanket on demand. That is exactly what happened back in April of 2022 when the 504 rate increased by 85 basis points in a single month in response to the first of the Fed’s 12 hikes to its benchmark Fed Funds Rate. Demand, which had been running well in front of supply for years, fell sharply and continued to erode as rates kept moving up, before topping out in December of 2023 at 7.01%.
As we have shared with you many times before, we believed that supply would accumulate and a price correction would be the result. That did not happen. Instead, supply fell along with demand as would-be sellers stayed on the sidelines to wait things out. It worked. Prices are still at peak levels. But, now that rates are declining again, we may see that process reverse itself. As demand picks up, so will supply as those owners who were holding off, enter the market in anticipation of more buyers in play to acquire their properties. If this occurs, it would be good for both buyers and sellers, as buyers would pay less for debt, but sellers could still realize their pricing goals. Transaction velocity could pick back up without causing a price spike or decline; not a bad outcome, all things considered.
The cost of debt is not the only important variable in the owner/user market mix, but is certainly at the top of the list. It is too soon to quantify the actual impact of the recent rate decline, but it is worth careful scrutiny. Our guess is that Q1 sale numbers rise sharply, as those buyers and potential sellers closest to the decision line will make their moves.
So, if you are the owner of a highly appreciated asset and you are at or approaching retirement age, what should you do? Should you take the sure thing and cash out? If you did, you’d walk away with an after tax profit you never dreamed of. That’s a fact. If you hold your property, is it worth the risk of correction and are you ready to hold the property for years until another market peak? Where you draw that line is up to you.
A quick story. Right now we are in negotiations for the sale of a small land parcel in North Orange County. The owners (lifelong friends) bought the property 34 years ago for next to nothing. They are both in their late 70’s. We have two offers, both of which exceed their price expectations. We have advised them that they could probably hold out for a little more, as each buyer is highly motivated. They discussed that option and agreed that enough was enough and instructed us to go with the buyer who is most likely to close on time. They didn’t want to risk scaring off both buyers and lose the chance to achieve their overall objective, which is to tie up loose ends and divvy up their profits while they are both still in good health.
The question is: when is more just more in your mind?
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