Last Thursday, the SBA lowered the interest rate for its popular 504 loan to 6.04%, a 16-basis-point decline from July. In fact, this key rate for owner/user acquisitions has been on the decline since peaking to just over 7% late last year.
While we are pleased with the direction on rates, we predicted a slightly sharper drop for the month. Our friends in the lending business were betting on a rate in the 5.9% range that would have given the market more of a psychological boost. But, things are headed in the right direction for buyers and we believe there will be further declines, especially if the Fed follows through on its hints of a rate cut in September. That action, if taken, will put downward pressure on the US 10-year Treasury yield, a key benchmark used for setting commercial property mortgage rates. See last week’s post for more on this topic.
As we have shared with you many times, the pricing on industrial owner/user buildings in Southern California has held near the market peak of 2022 despite the massive spike in mortgage interest rates. We expected a price correction that reflected higher debt service costs, but it has yet to materialize in any significant way. Yes, buyer interest has declined, but supply remains thin, as existing owners are loathe to give away their 3% mortgage rates by trading into a bigger better building.
That said, the recent decline in rates does offer substantial relief for potential owner/user buyers. Let’s take a look at a hypothetical offering to make our point. Assume a 10,000-square-foot building in North Orange County that is offered for sale at $390 per square foot, or $3,900,000. A buyer acquires the asset with a 10% down payment ($390,000) and finances the remaining 90% of the purchase price through the SBA 504 program. Typically, there are two loans funded in a 504 deal, a 1st Trust Deed funded by a bank of approximately 50% of the purchase price, and a SBA 504 2nd Trust Deed of the remaining 40% of the purchase price. These percentages can vary, but this is the typical deal structure.
In our scenario, the 1st Trust Deed loan would be $1,950,000. One of our favorite bankers quoted a rate of 6% last Friday. Using a 25-year term, the payment would be $12,564 per month. Last November that same loan would have been originated at 7% and the payment would have been $13,782. For the 40% SBA 2nd Trust Deed of $1,560,000, the payment now at the current rate would be $10,089 vs $11,036 at 7.01% last November. That’s a combined savings of $2,165 savings per month, or $.21 per square foot per month. In just the first 10 years of the loans, that represents a savings of $338,727 in interest paid. And that’s with just a 1% difference in the rate. If the Fed comes through with a rate cut, we could see mortgage rates move substantially lower in the 4th quarter.
This is good news for sellers, too. The decline in rates is good medicine for chasing away a correction in asset valuation, as buying power increases as rates decrease. We could even see upward pressure on sales prices if supply doesn’t increase along with demand. But, we hope that supply does pick up so that buyers have a better chance of actually finding a building that fits their operational needs. Otherwise, they will opt to lease instead and sales activity might remain sluggish despite lower rates.
The Fed sent a pretty strong signal that a rate cut was in the offing for September, and many experts are predicting an outsized 50-basis-point cut in the Fed Funds Rate in response to disappointing job reports and an agitated equities market that both hint at a harder economic landing than previously anticipated.
We shall see, but in the meantime, it’s time for buyers and sellers alike to re-think their acquisition and disposition strategies. Like we always say: It’s always good to be in the know.
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