Navigating Higher Than Average Interest Rates In Real Estate

In late January 2024, four U.S. Senators, specifically Elizabeth Warren, John Hickenlooper, Jacky Rosen, and Sheldon Whitehouse, sent a letter to U.S. Federal Reserve Chairman Jerome Powell urging him to reduce interest rates. "As the Fed is weighing its next actions in the coming year, we encourage you to take into consideration the implications of this interest rate decision in the housing market," they wrote. "The direct consequence of these rates has resulted in a significant rise in the total cost of buying a home for consumers on average," they added.

It is estimated that the U.S. housing market is almost frozen, with only people who need to sell or buy and move to another location for various personal reasons. While mortgage rates at the beginning of January fell a little to about 6.7 percent, the average rate soared to 7.8 percent in the middle of October 2023. In November 2020, the rate was about 2.7 0.7%, and that's a difference of 5%.

The issue is that inflation isn't yet at the Fed's 2% target goal. In 2020, it was at 1.2 percent, but the cash injection into the economy due to the pandemic has helped boost it to 8% by 2022. In the absence of making debt more expensive, rate hikes could have resulted in a hyperinflation crisis, which could have grave negative consequences.

There are two ways to fight it. Fed has two tools to stop it. Quantitative tightening means that they will no longer purchase bills and treasury securities, as well as mortgage-backed security (MBS) at banks, so they actually have less cash available to lend and also more interest rates, which means banks must increase the rate of lending for their clients since the money they get through the Fed is becoming more costly.

What are the effects of rising interest rates impacting the real estate industry?

To say that the high rates of interest have ruined the real estate industry can be described as an exaggeration. The majority of real estate developments are funded primarily with debt and only a tiny amount of capital from the developers. The housing market is affected, but the same is true for retail and office commercial real estate, particularly in major cities in which there is lots of competition.

Even though the Class A buildings remain relatively good, as big corporations and professional offices with high-end amenities want stylish, trendy office spaces that will attract their employees and impress their customers, I've noticed that the older buildings that are not ESG-compliant aren't faring as well. Many workers prefer working at their homes (WFH) and assume that they're not dismissed due to poor economic circumstances or that artificial intelligence (AI) hasn't completely replaced these workers yet.

Positively, parking garages and warehouses are doing well, especially since online shopping is highly well-known.

This situation has become so dire that I have heard of reputable developers selling off their offices in areas such as San Francisco, New York, and Los Angeles just to offload specific properties off their books. They recognize that at very high rates of interest, math for these investments is no longer working.

Additionally, there are mountains of corporate debt, which was initially given at low interest to companies to finance their capital expenditures and operations before the Fed increased interest rates. Many companies are struggling to pay their monthly obligations, and with their loans coming due, they will need to negotiate with their lender or a bank with higher interest rates. Some of them may find that they'll have to end the deal when their expected cash flow does not meet their outflow requirements as stipulated in the contract.

The goal for businesses is to stay afloat.

At the moment, the concern isn't how to generate lots of revenue for some companies. For many, the goal at present is to stay afloat until the interest rates drop, at which point they'll be able to pay back the loans that have been renegotiated by predicting decreased cash flow or revenue for their business.

If you're running your own business, you might have spoken to your banker about renegotiating the terms of your loan to ensure you don't miss payments. This might mean adding years to the timeframe for repayment; however, it is also possible to fall into default on the loan -- within the reason, of course. Suppose the project no longer makes sense, like a primarily empty-off ice building. In that case, it may be necessary to find an owner to purchase the property or change your business into something different.

Apart from talking to the lender (or lender) regarding restructuring your debt to make it more affordable to service, You also have to make the most of your marketing efforts. This is the right time for innovative marketing strategies and for your sales staff to achieve and surpass their targets. Making sure that debt service can be met by your cash flow is crucial to being able to get through.

The fight to live an extra day is not a phrase to be used for your benefit. It's what you have to do.