For decades, the SBA 504 loan program has been the go-to source for buyers to acquire owner/user buildings in Southern California. It still is, though things aren’t getting any easier these days.
On October 5th, the SBA announced a 41-basis-point increase to 7.21% for its 25-year fixed rate loan.
That same loan was priced at 5.88% just 5 months ago.
In January of 2022 it was 3.06%.
In August of 2020 it was 2.16%.
Conventional wisdom would be to assume that if borrowing costs for an industrial building more than double, prices would have to come down to compensate for higher debt service payments. Econ 101, right? Well, up until now, it hasn’t happened.
Even with high interest rates, rampant inflation and a slowing economy, there has been no significant price correction. But, the alarms are going off. Buildings are sitting longer. Fewer qualified buyers are circulating, fewer sales are closing and the price run-up stalled out in the final quarter of 2022.
So, why no price correction? Answer: no inventory. There just aren’t enough buildings on the market to kick start the correction. If the current trend continues, the market will just stall. Transaction volume will slow to a trickle and would-be buyers will just lease another building and wait for rates to come down again. If the trend reverses and the inventory we have been expecting pours onto the market, the correction will begin in earnest and well-deserved equity will erode quickly.
Many of you out there bought your buildings in the past 10 years, you have a fixed rate loan at a ridiculously low rate and the building still works for your business. If that is the case, good for you. You are in good position to ride out a downturn and stay in through the next upcycle. So, if your business can function out of your current facility for another 5 to 10 years, staying put with that killer mortgage sounds like a good idea.
Then there are those of you who bought 20 years ago or more. You have probably paid off most or all of your original loan and your building is worth 4 to 8 times what you paid for it. In other words, you are literally sitting on a pot of gold. If that is the case, good for you. You deserve it. Some of you paid $40 to $50 per square foot for your buildings in the 1990’s that are now worth $400 per square foot or even more today.
You may have read our recent post about staying at a blackjack table for one too many hands after a run of good cards. Basically, if you are a long term owner with little or no debt on your building, you have had one helluva run of good cards and it may be time to cash in your chips and exit the casino. Cashing out takes discipline after such a good run. No one wants to walk away from a good game. Trouble is, any game of chance will eventually go bad. Odds are odds and gravity works.
Our job is to help people make good real estate decisions and experience has taught us that sometimes it is best to be subtle and patient as a property owner evaluates his disposition choices. Other times we’ve found that raising our voices as we shake our client by the lapels is called for. This is one of those times. If you’ve had even an inkling of selling your building in the next few years, the sign should already be up. Prices are stalled near the top and there are still buyers out there who need good space who have a long term investment strategy. Everyone can still win, but that can change quickly.
Remember the old Ernest Hemingway response to the question about how he went bankrupt: “Gradually, then suddenly”. Market corrections tend to work the same way, and we have run out of reasons why we won’t be in one soon. That may sound like a scare tactic, but we will sleep better knowing that we warned you while you still had time to take action.