Last week I wished you all a Merry Christmas. This was my way of adding some lightness to the decorations that started appearing in stores during the last week of September.
But then I got serious and went into the conversations I’ve had recently with investors, tenants and owner-occupiers. If you tuned in, interesting challenges were revealed. If you missed the column, below is a brief synopsis of what I’m hearing from investors.
Our industrial market passed a turning point in mid-2020. For the first time I can remember, the resident premium disappeared and investors began paying more for properties than those they bought to house businesses.
Deep capital pools, an insane appetite for yield in a stable asset class, and tight supply caused pricing to hit a crescendo in May 2022. With all the happenings in the world – inflation, recession, global strife and rising interest rates – investors, especially institutional investors, have taken a break.
Individuals are also very careful. Many need debt to purchase investment property. Since interest rates have now exceeded 5.5%, the resulting capitalization must be North to avoid negative leverage (return on dollars invested minus this cap). So with fewer buyers and higher rates – yes. Prices have started to fall.
Another week and a few more conversations have passed. One in particular, which I thought was a column, was worthy.
We are marketing an investment opportunity in Chatsworth. This also includes the owner’s desire to sell the building and – after the deal – to remain as a tenant. This deal structure, known as sale-leaseback, has caught on lately as our values have eclipsed sanity.
However, this particular offering has a bit of hair. Configuration, company ownership and reuse after resident moves out in 10 years. Yes! Investors fear for the next round. Much like a game of billiards where the current shot pales in comparison to “leave” — investors today look beyond the return against their risk once the tenant moves into the future.
As the market changes, an investor’s risk appetite is filled with the need for more return. In general, institutional investors – those who are publicly traded or invest in pension funds as correspondents – are looking for one of two types of deals – core business or value added. The former falls right into the mayor’s office and the latter requires some work to get the engine revved up. Our listing is neither nor.
Also, given the market and global volatility, many institutional types play wait and not trade.
Which buyers are left? Private capital like your neighbor who owns a mall or office building.
Many private investors have considered our listing. Most passed. Too risky, when the tenant moves out, we don’t like the floor plan, how we retrofit the building in the future and what insurance we have that the tenant stays in the house – are common refrains.
But another interesting dynamic occurs. Unless motivated by a need to place money through a tax-deferred exchange, private capital can earn 3-4% investing in government bonds. These offer a 10x year-on-year return and come with the full trust and credit of the United States government – also known as very low risk.
If I buy with a 6% yield and decide to finance the purchase, I need to be very aware of my borrowing costs as the borrowing constants are now above 7%.
Allow me a simple example. Let’s say you buy investment property for $2 million. If $1 million is borrowed at 5.5% interest, the simple interest payment is $55,000. Easy.
But how is the $1 million principal repaid? This is where amortization comes into play. A fancy way of repaying the principal over the life of the loan. So. If the $1 million principal is repaid over 25 years at 5.5% interest, the annual payment is now $73,690. Your return on the $1 million (rent from your tenant) is $120,000, but your loan repayment is $73,690, a net amount of $120,000 to $73,690, or $46,310.
Do you see the problem? Your $1 million invested returns $46,310 per year. Take that same $1 million and throw it into government coffers and you make $40,000. Hmmm.
What does it all mean? Continued downward pressure on pricing. If you want to sell to a private investor, be realistic. Times change!
Allen C. Buchanan, SIOR, is a director at Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104. His website is allencbuchanan.blogspot.com.
https://www.ocregister.com/2022/10/08/what-are-investors-telling-us-about-real-estate/ What do investors tell us about real estate? – Orange County Registry