The yield on US 10-year treasuries has unexpectedly fallen to a multi-year low in the last few weeks after rebounding earlier in the year.
This is significant to the commercial property market because that yield is used as a benchmark for setting commercial property mortgage rates. Lenders and investors look to the 10-year for guidance because they believe it is a good indicator of the long term cost of capital and health of the macro economy.
An increase in long term bond yields signals an expectation of higher GDP growth and inflation. But, the anticipation of lower growth and inflation in the future spooks investors into buying longer bonds for safety, driving demand for them up and their yields down. That seems to be where we are today.
In essence, this less than favorable economic outlook is great for borrowers, as mortgage rates fall as bond yields decline. This good news-bad news scenario makes for some difficult decision making for investors and business owners. If economic forecasts are less favorable, is it still a good time to be borrowing money to make acquisitions or expand business operations into a new facility?
To be sure, the right answer to that question is unique to each investor or business owner:
For a private investor looking to balance the use of leverage with the need for cash flow, lower debt service is a welcome and critical component of asset performance. But, if a slower economy reduces demand for space, lease rates could fall to a point where cash flow becomes negative. Lack of measurable rent growth increases investor risk, which drives cap rates higher and prices lower. No investor wants to buy at a 5% cap based on today’s high rents and be forced to sell at a 6% cap on lower rents. Not good.
For the business owner looking to acquire a facility for his own use, lower mortgage rates reduce fixed operating costs, which is a good thing. However, those low rates have been largely responsible for today’s high price point. That’s not good because buyers have to borrow more to acquire property. So, it is very important to acquire a property that the business owner can comfortably afford and use efficiently in the event of a downturn. If that is not the case, it may force a sale during a market correction. Also, not good.
For investors and owner users, it is important to look as long term as possible, especially considering the fact that this bull real estate market is the longest on record. Underwriting the risk of any acquisition should be carefully executed and must include a realistic evaluation of local and macro-economic conditions and forecasts.
For those looking to dispose of property in today’s market conditions, the same rules apply. Holding on just to avoid paying taxes on a huge capital gain may not be the best thing. Market corrections have moved the needle on property values by as much as 50% in previous cycles.
It is important to make sure that evaluating downside risk is part of any investment strategy. Selling in a market still moving north is tough.
Nobody likes to leave money on the table. But, selling in a market in the throes of correction is gut-wrenching to say the least. So, for investors looking to retire soon and reduce their risk profile, this may be the best time to sell. For others who are still looking longer term, holding quality real estate during a correction may be the right move.
Bottom Line: Make sure whatever decision you make takes all angles into consideration. You will be glad you did.