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March 29, 2022

In The Interest Of Rates: North Texas Commercial Real Estate Leaders, Experts Weigh In On The Rise

It’s a measure many were expecting as inflation continues to rage in the United States. In recent weeks, the Federal Reserve raised its short-term target to between 0.25% and 0.50%, the first lift since 2018. And a question still lingers as the central bank looks to fend off a recessionary climate: Just how far will the hikes go this year?

It’s not all doom and gloom – opportunities also arise alongside the challenges and added riskiness that could impact the broader real estate community in the greater Dallas-Fort Worth area and beyond. And there’s something else to remember: North Texas is arguably one of the best-insulated markets in the country as residents and businesses continue to migrate to the region with occupancy and rental rates in key asset classes outpacing demand.

Members of our real estate team, including Anna Butler (me), Bill Hethcock and Spencer Brewer, asked commercial real estate leaders and experts based in the region what they’re keeping an eye on in their particular slice of real estate when it comes to rising interest rates. You’ll be able to find interest rate takes from those in residential real estate later this week, too.

Mayor Eric Johnson, City of Dallas: “Dallas is booming, and we are well-positioned to continue our growth. But we recognize that national and international conditions, such as inflation and rising interest rates, could increase the cost of doing business in our city. Dallas has often defied and outperformed macroeconomic trends, but we must plan ahead. Rising costs to build and borrow make it even more imperative for our city government to fix our permitting processes and cut the property tax rate so that our prosperity can continue, even as the world around us changes.”

Jon Altschuler, founder, ALT+CO: “When you’re an intermediary, you want contextual conditions really good or really bad. Trades happen in both contexts. It’s when things are spinning sort of sideways and market participants start pointing to their uncertainty as an excuse for not doing something, that’s bad news for business volumes. Whether rates go up or down, I hope they move in such a manner that participants maintain directional confidence one way or the other.”

Jeff Brand, managing partner, Brand Partners: “If the underlying fundamentals of a property investment or development are sound, there is less to worry about, especially if you are in it for the long game. Problems may arise for those who may have purchased properties or built to a lower cap rate based on the ability to get cheap debt. Cheap debt made marginal deals work, which may prove to be challenging when looking to sell. Merchant and build-to-suit developers are most at risk of getting squeezed on their buy-sell cap rate spread, since rising interest rates will cause yields to rise and thus prices to decline.”

Don Braun, president, Hall Group: “As with any cost increase, an increasing interest rate environment can pose some challenges to commercial real estate, particularly more marginal projects. However, we would expect that any continued increase in interest rates will be accompanied by strong economic growth – which we believe will be particularly true in the DFW area – and inflationary pressures, both of which are generally positive for real estate investments.”

Susan Gwin Burks, senior vice president, Avison Young: “Our clients have definitely expressed their concerns over increased interest rates and the effect it will have on yield curves and ultimately the potential decline in asset values. They have also expressed their frustration with the rise in interest rates and another potential loss of value coming on the heels of working through the challenges that COVID threw at them. However, on the flip side, some believe that the interest rate increase is a sign of stronger economic growth and could in fact lead to an increase in demand for space and higher rents, offsetting decreases in property value due to the rate hike.

“All that being said, Dallas was the number one market for total investment dollars for the second year in a row hitting $46.9 billion in 2021. With the mass migration into the DFW market, the new investors entering our market, and a healthy appetite from current owners/investors, our clients believe DFW is still the best place to be.”

Geoff Ficke, executive vice president, Colliers International: “Since my team sells and finances triple-net and credit tenant lease property, we work on a range of different property types including office, medical, government, retail and industrial. My team’s primary focus is the underlying credit of the tenant. Strong lease guarantees tend to positively position NNN and CTL during periods of economic uncertainty. Throughout the pandemic, we witnessed tremendous demand and capital migration into industrial, government and medical asset classes. We expect this to continue. Office and retail have both held up well but following COVID, the offering activity is really asset-specific within these sectors. Government-leased buildings and e-commerce resistant retail have been winners within these sectors. We believe that in 2022 investors will place a greater emphasis on property fundamentals and not just cap rates and current yield. Scrutinizing the price per foot and market rents will be more prevalent by investors and lenders.

“Historically, commercial property investment has been a terrific hedge against inflation. This assumes an asset has healthy annual rent escalations or strong prospects for rent-growth appreciation in the near term. From my perspective, investors will flock to certain product types that have strong potential for rent growth. There is a lot of uncertainty in the market stemming from the changes within our capital markets, the Russian waged war in Ukraine, supply chain issues, and the potential for additional COVID variants. During indeterminate times, tangible assets like real estate can be a safe haven for prudent investors.”

Matt Haley, managing principal, Apricus Realty Capital: “All else remaining static, the Federal Reserve’s plan to increase interest rates through 2022 should have a negative impact on business activity/demand and asset values. But with real interest rates deeply negative, the impact may be a bit delayed. However, high inflationary pressures are a greater risk and must be quickly contained.”

Tanya Hart Little, founder and president, Hart Advisors: “Inflation is a systemic problem which will impact most commercial real estate owners and investors. As prices rise, the majority will pull back on spending which will directly affect the tenants who pay rent, specifically in the retail and hospitality sectors.”

Marshall Mills, president and CEO, Weitzman: “We’re watching inflation closely, but being in Texas with its strong residential growth means that there is a growing need for our retail centers and tenants.”

Bob Mohr, founder and chairman, Mohr Capital: “For investment teams buying or selling right now, the recent volatility in the debt markets has affected the ability of some lenders to maintain their pricing on current transactions, which in turn has put pressure on investors’ yield. Mohr Capital currently has over $300 million of transactions trading now, so we are moving very quickly.

“In addition, increasing rates will impact owners as they try to evaluate the pros and cons of fixed versus variable debt while accounting for the few upcoming rate hikes promised for this year. This should have further pressure on Cap Rates almost regardless of how much money is in the market today.”

Blair Oden, EVP, Commercial Real Estate, Texas Capital Bank: “Traditionally, a rising inflationary environment, which leads to rising interest rates, has been good for CRE. In this case, I believe the real risk is stagflation – rising inflation with little to no GDP growth. Texas has insulating factors which will help mitigate potential recession impact as compared to most of the United States. That being said, DFW and Texas as a whole are, and will remain, a major job-creating machine.”

Alex Perry, Partner, Biel Partners, on the land market: “Hope the Fed isn’t reading this but it’s going to take more than a quarter point to slow this down. And as the great T. Boone Pickens would put it: ‘When the tide goes out we will figure out who is skinny dipping.’”

Al Silva, senior managing director, investments, and executive director, multi housing division at Marcus & Millichap: “Historically, overall commercial real estate cap rates have averaged a spread of about 250 basis points above the 10-year Treasury, with that spread becoming compressed in hot markets and wider during times of stress or uncertainty. In recent years, as a result of the growth, DFW has experienced and the ensuing flood of capital we have seen, those spreads in DFW multifamily have compressed quite a bit. Even if interest rates go up a fair amount, DFW will remain an attractive market for multifamily investment because of generational employment and population growth and limited housing supply. So, any increases in cap rates will probably be limited compared to other product types and other parts of the country due to the amount of capital that will continue to see DFW multifamily as an attractive place to place investment dollars.”

Kip Sowden, Chairman / CEO, RREAF Holdings, LLC: “Locking in fixed-rate debt will eliminate uncertainty in the largest cash drain in most real estate investments, even if it is more expensive in the short term. We believe holding rental real estate with fixed-rate debt through an entire inflation cycle will be profitable. … As interest rates rise, the spreads between the cost of debt and cap rates start to contract and eventually disappear. At some point, negative leverage can result, which should shrink the amount of liquidity in the market thereby putting upward pressure on cap rates resulting in lower prices for real estate. Notwithstanding that pressure, there still exists a comfortable margin between the cap on construction costs versus market cap rates – RREAF looks for a spread of 250 basis points or more. As cap rates rise and construction costs increase these margins shrink which would make development more risky. We are seeing so much migration to the markets in which we focus and transact (south and southeast) that demand continues to outpace supply creating increased rental rates that we believe will offset the projected rise in cap rates, meaning values are increasing in spite of anticipated increased cap rates and increased construction costs. In other words, margins are being maintained.

“As long as we have a free enterprise system and allow the markets to work without governmental intervention, eventually we will move toward a healthy equilibrium. This means that supply and demand should come into balance with rental rates leveling off and construction costs becoming more stable.

“In the short term, RREAF will continue to fix any floating rate debt, assuming we can do so with a reasonable fixed prepayment penalty vs. defeasance or yield maintenance, and we will continue to seek well-located sites to deliver residential housing to markets with an expanding population growth.”

Jody Thornton, president, Capital Markets, Americas, JLL: “People a long time ago said that cap rates are not going to track interest rates, which is inaccurate. Everybody’s looking at a levered return. At some point, cap rates will have to track in some form. I’m not saying basis point for basis point, but interest rates will have an impact.”

 

Source: https://www.bizjournals.com/dallas/news/2022/03/29/commercial-real-estate-interest-rates-north-texas.html