How to Invest in Commercial Real Estate

142 of 143 episodes indexed
Back to Search - All Episodes

Episode #085 - Current Market Update: Interest Rates RISE AGAIN!

by Criterion, Braden Cheek, Brian Duck
November 7th 2022

Today hosts Braden Cheek, Brian Duck, and Joel Thompson discuss the current state of the market and its potential impact on real estate. What are your thoughts? Let us know in the comments section.... More

you couldn't, you couldn't lower the rates anymore. To stimulate the economy. You had to give out money. So then they gave out a bunch of money. So now we have the lowest rates we've had in our lifetime, we have trillions of dollars of printed money just created money into the system. Then you have uh economy shut down so people are at home not spending that money or or other money. Okay. And so you have all this pent up demand. Welcome back to how to invest in commercial real estate. My name is Brandon cheek and I'm joined by my co host today, Joel, Thompson and brian Duck. What's up guys? Crazy time to be in real estate right now. It just keeps getting crazier feds met again yesterday and raised another historic three quarter of a point rate hike painful. I felt that one. I don't want to hurt. So what prime is now seven is out, I think that's what was it, was it three and a quarter when it started three and quarter when it started the rate I started.

So you know, and the cost of borrowing roughly is probably prime plus half a point give or take, you know, your credit and what you're getting on the rest of your terms. But yeah, so that means the general cost of capital for real estate deal was 4% or sub 4% you know, 375 mid threes in an apartment complex. So that's a massive difference because primes at seven. So half a point above that 7.5 which we just got a deal locked in at half a point above prime before it locked in. So that's a real rate. So I mean 7.5 today. It's crazy. And uh, the, the interesting thing about the meeting, which we want to talk about is the signaling that the rate hikes are not going to stop. Uh, so we're going further higher. We don't know exactly how high, but I would guess Another point or two before this is over. So that puts prime at 8-9% by the time they start easing. So they didn't give any indication yesterday on timeframes or amounts or anything at all.

They're probably reluctant to do that. So I don't think they did, but I didn't, they know, but they do try to give guidance and, and the guidance was, hey, we're, we're not easing up here. Uh inflation is not under control yet and we're gonna keep going until it is. So I was listening to pal yesterday and what we want to convey to everybody listening today is he was basically saying, hey, we can't ease up until we get inflation under control, which it's not today. And pause right there. That's, that's the basis of this, right? I mean that's, that's the goal is out of control. Month of a month inflation year, over year inflation, I mean year of year inflation is like what, 7% from this time last year, something like that, still going out of control but it is still uh unacceptably high. And so uh he's saying hey we're not quitting because I guess they're they're afraid of it being in, you know inflation becoming entrenched in the economy and and part of the daily life and and they're they're not going to allow that to happen. So if anything, it sounds like they want to overshoot on the rate.

Yes. Yes and not not undershoot. So because they can always start creeping back down when they want to. Yeah and that's what he articulated yesterday. Is that that the Fed has tools that they've used successfully in the past to to stave off inflation or to help uh in a recession. And so he's like hey we're we're raising it and we're gonna keep raising it until we get inflation under control. And if and if doing that sends us into a recession, we have then we'll have plenty of interest rate uh decreases to help monitor that. And then the Feds can how optimistic of them. Uh you know, but for us, we wanted to talk today. Okay. So what does that mean? Because the lending situation in commercial real estate has just gone totally out of control and I would say that cap rates haven't adjusted at all if they've gone up a quarter point, that would be a best case from what I've seen. So let's start on on why the Fed is raising the interest rates. I mean brian why is why why are they raising the interest rates to curb inflation? They said they're going to continue to do it until inflation is under control and and to get it out of being a part of our economy.

So why is raising the interest rates getting inflation back in control? I'm not, not, not an expert on it, but but let's take, you know, the biggest companies and even small companies around the country, if they want to spur growth within their their own company, they're gonna go out and borrow the money, you know, to buy new machinery or whatever it is, higher people, whatever it is, that's what they're gonna want to do well now they're not going to do that as much and so that helps keep prices down because they're not they're not growing, right? Um There's other examples. I don't know, I don't feel qualified. You can see it all over. I read an article this morning that meta pulled out of a 600,000 square feet on their brand new HQ two in Austin. Right? So I mean from the biggest companies in the smallest companies, nobody can afford to grow when the cost of capital in the cost of debt is this high, it's kind of my basic level of understanding. Yeah, I mean I think our, let's admit our understanding is basic at best. Uh And so I don't I don't know that I'm even qualified to talk about exactly how inflation is going to come under control just by rising interest rates, but we do know that it does make the cost of capital expensive and so it will slow construction construction is that's really the main interest rate that that the floating rate, the short term rate that they use for construction projects, you know, the cost of capital for growth.

But even the raising of rates and the feds saying they're gonna be raising rates could also psychologically have companies pulling out of big projects because they think, ok if we raise these so high recession is gonna follow, we've gone through this 10 year bull cycle run. And so even the psychological nature of it could slow things down enough to help bring inflation back under control. Yeah, they're worried they might do all this growth. They may they may bite the bullet on the higher interest. But then on the other side of it, if it's a recession, people are gonna buy whatever their products and services. So yeah, it really slows it down. I think it's really fascinating just like the macro aspect of this because when you were in the middle of Covid in 2020 you're this term called quantitative easing. And if you had, You know, Children or employees or business or or really a bank account were alive, you notice you got some free money, everyone, you know got free money, right? The PP. P loans, like if you had 20 employees, you probably got hundreds of thousands of dollars.

And and forgive like it's completely forgiven. You don't have to pay it back. You could get more. Um I forget what the loan was called, but you have to pay that one back at like 1% interest a year or something crazy over 30 years and now when they're raising the interest rates were calling that a quantitative tightening period. Right? So I find that it's interesting when COVID happens, the economy kind of shuts down and we need to stimulate this growth. It's it's almost like maybe we stimulated too much growth. Right? Is that a good thing to say with all the free money because everybody went out and spent it. Right? And then all of a sudden um supplies are are dropping and so the costs are going up because there's not much supply out there. But so that double whammy just caused all kinds of havoc with inflation. Well it it almost seems like we we went too far then and maybe we're having to go that far now equally on the on the other side. Maybe we just could have done less easing. So we could have gotten less tightening. Is that is that a fair statement? I don't know? Who knows?

Maybe it would have helped. Maybe just the supply issues would have done it by itself. I don't know, once again disclosure, we're not we're not experts at this at all. But you know, we shouldn't have been at near 0% interest rates at the time. Covid hit. That was a mistake Uh by both the Fed and the administration's uh you could you could maybe blame Obama although he was coming out of the recession in '08 during the Trump years. There's no reason to lower interest rates during those years, the economy was booming. But what everybody wants a great economy and everybody wants votes. And so we're doing things that appease voters. And then uh we we flood trillions of dollars into the economy because that's the only thing we had available to us because rates were virtually at zero. You couldn't you couldn't lower the rates anymore. To stimulate the economy, you had to give out money. So then they gave out a bunch of money. So now we have the lowest rates we've had in our lifetime. We have trillions of dollars of printed money.

Just created money into the system. Then you have uh economy shut down. So people are at home not spending that money or or other money. Okay. And so you have all this pent up demand, uh you have factories shutting down. Uh and and now you get back log of good. So when the economy started back up again, everybody's flush with cash, the products took a while to get back online. So that started pushing prices up. There's so many things that went in to build this inflationary tail and you know, that the chatter out there is, oh, it's it's biden's fault because it happened during his watch. But there's so many other things over the last eight years that really got us in a position to perfect perfect position to have this runaway inflation. And now we're dealing with it. And one of the ways we're dealing with it is just jacking up interest rates as fast as we can do it. So that, so I've got a question. So, back to how this affects real estate. I'm not familiar with this because all the deals that I've been in with precision and all the ones we've done with criteria, we've always done locked interest rates.

Right? So, but aren't there probably, uh, investors out there are real estate investors are or whatever that um had floating interest rates. Is that possible? And so what's happening? Obviously those rates are going up. But what are those people doing at this point, Do you know, weeping? Yeah. Well, I remember a lot of people talking about floating interest rates several years ago now, if they kept those floating rates, uh, you know, after Covid and as this thing started to heat up or if they tried to quickly fix, you know, maybe they tried to, you know, fix it this last spring when the feds were kind of like, okay, we're gonna start doing this. Hopefully if you're if you're floating on the way down and you hit the lowest record, like in history and you don't like it. Well you never know when that point is gonna happen. But rates were so low. I can't imagine anybody taking out a floating interest rate over the last few years before, you know, before Covid hit. I just can't imagine. But on a, on a stabilized deal, I would agree on a stabilized degree. Yeah. In a construction deal or something else you may, you may go floating because I think it makes you write a lot of them are like that they may not let you go.

So now we have the opportunity to forecast how is this thing going to play out and you know, listening to power? I think they're gonna overdo the hikes, but then they're gonna be quick to reduce rates if and when it causes a recession or some other problem. So you've got to be opportunistic in the market right? Like in the cycle that you're in, you can't just stop. You have to study this. You have to study the cycle and you have to figure out, okay, how can I make hay with this? How can I seize the opportunity when rates were going down? You know, when they were so low in 2019, 2020 even the beginning of this year? Record low three and a quarter, maybe your cost of borrowing is 3.75 or 4%. We bought a ton of deals. That's how you take advantage of cheap debt. So for everyone listening now and you know, we're acting like it's so bad. But what are the opportunities in the cycle right now where debt is so expensive, but yet we all know the world's not going to stop transactions are going to be done. So what can, what can we look for? Well, I don't know.

I mean, there's, we will slow down in our acquisitions, uh, goals for the last part of this year. And for next year, I would say, you know, a couple of new construction development deals were still pushing through because they take a year and a half, two years now I do have to set aside more money for interest. My carrying costs are gonna be be higher during that, that 18 months, 24 months. But I'm at least optimistic that a year and a half, two years from now rates are gonna be headed downward. And so what I think about is okay, I'm gonna build this apartment complex and my cost of carrying funds is going to be higher. But inflation is still real right now and rates, rental rates uh asking rents are still going up so that that will help my project on the back end. So if I can just get this thing built then maybe in two years when it's stabilized, I can go ahead and look to lower the debt. Uh now that that's somebody say that's a little bit of a risky game, but we're already in the development now.

So it's hard to kind of put the brakes on it. And to be honest, there'll be less projects getting started because of these higher rates. And so maybe you have less competition when you're finished with new projects coming online, less competition to to sell it maybe, or because there's less or less, let's say less, you know, competition as far as other new apartment complexes because they're just less, it's going to be in the pipeline given the uncertainty in the market. So possibly rental rates could go up. Yes, hopefully, hopefully. Okay. Yeah. Because you're still gonna have population growth, you're still gonna have growth into new markets and everything like that. I think the longer rates stay high, which I don't really want them to stay high very long. But the longer they stay high, the more opportunities there will be in the long run because because these people that had low rates and the deals barely worked with the low rates are now going to have to refinance and there's not getting anywhere to get cheap money right. The risk of default is a lot higher. I was going to say that that's an opportunity to look out for us. There's a lot of people that may be over leveraged themselves, there's maybe a lot of projects that got started that couldn't get completed or renovations maybe.

So I think there's an opportunity to pick up some of those deals. I also think there could be an opportunity for a great asset. Um You know, and and the seller's got to sell you, you're dealing with maybe a reit or a fund that had a specific timeline and they had to sell. Obviously now is not the best time to sell, but people are always going to have to sell somebody's gonna die or whatever. So picking up a great asset at at at a decent price but a discount considering where debt is and then just penciling in a refi in a few years, I think there could be several opportunities there. Well, if you're listening, we'd love to hear your thoughts. Um you know, comment, let us know what you think about the interest rates. When are they going coming down? How high are they gonna go? Uh We'd love to hear feedback because obviously we don't know, we have no crystal crystal ball with respect to this stuff. So. Absolutely. Well they're probably staying high for a little bit right next year is probably, I mean we're not gonna see rates in the threes next year, are we? I think that's right.

I don't think anybody would argue with that. I would say plan on higher rates for at least a year, year and a half before they start coming down, okay year, year and a half before next fall. I mean let's revisit this topic but I don't think they're gonna lower rates before next fall. And I bet you were close to 8.5 9 by next summer. So we'll see, oh I don't know how close your guest is here. Yeah we'll clip it for sure. But anyway, thanks for joining us on another episode of how to invest in commercial real estate. And this is our quick little synopsis of the november interest rate hike. We'll catch you next time. Thanks guys.

Episode #085 - Current Market Update: Interest Rates RISE AGAIN!
Episode #085 - Current Market Update: Interest Rates RISE AGAIN!
replay_10 forward_10