By: D. Sidney Potter
Reading my 2022 real estate predications from last year, I essentially committed a Christopher Columbus type of error, in that I was so far off on what year end interest rates would look like, that Christophers’ mistaken belief that he had reached India instead of America, makes my real estate faux pas seem like a lunar shot hole-in-one. Which is to say, I should nearly lose my real estate stripes for having been so far off on interest rates, both commercial and residential. The all-too-common human trait of greed was naively overlooked. And coming from a person who on occasion has written profusely on the human trait of greed, I’m embarrassed to admit this oversight. From hindsight, major banks were at least decent enough in 2019 to 2021 to keep their home lending rates at the 2.75% to 3.25% mark for the 30-year fixed rate loan. And what with the cost of funds (COF) at 1% from the US government, that’s considered a reasonable spread at 175 to 225 basis points, and especially so given the 1% COF had been in that stratosphere for the preceding 36+ months. On the commercial side, the COF was about .65% at year end for 2022 and is much the same story, with the 10-year Treasury hovering at about 3.50% to 3.60%, and the lending rate to investors about 300 basis points above that mark. Remember, and at least historically speaking, the 10 Year T-Bill rate reached 15.84% in 1981 as a result of the Feds strategy to curb inflation. Is this a repeat. Let’s hope not.
Notwithstanding the latter, Jerome Powell and his Fed buddies hopped on the inflation train ride and said let’s raise rates (as an inflation buster I suppose), and the banks woke up and said gee wheeze, lets raise commercial and residential rates disproportionately to the cost of funds irrespective of the margin spread and do some profit taking; much the same way oil companies, property management companies on rentals, fast food outlets —- and used car salesmen (least I forget), have raised prices against consumers. If someone were to make a movie on the harmonic convergence of non-interest rate, non-contributor economic indicators, it would be called The Great American Interest Rate Price Rape. At least with the fast-food outlets, some of the franchisees and corporate owned locations are decent enough to post on their restaurant doors that they pay a “living wage” of $13 to $15 an hour.
Notwithstanding (again), and based on recent pontifications from think tankers, cable news spin heads, and respectable economists as of December 2022, expect rates to dip down to the mid 4’s to low 5’s by year end, if for no other reason to keep America in business. Greed, if played to the fullest in all of its requisite beauty will result in self-cannibalization. This is what big business does not want. Remember, the business of America is Business, and without this near biblical tenant, which is self-survival, it; meaning America, cannot function. All the latter is likely, EXCEPT in the event of another 100-year event, such as the second coming of another latter-day Plague, a protracted tactical nuclear war with Russia and/or the absence of a moral foundation from the money changers in the Fed or Wallstreet. If the latter were to occur, all bets are off in terms of interest rates.
Home Appreciation & Home Affordability
By and large (I love that expression), home appreciation will substantially decrease in 2023 and can be traced back to Q2 2022 in terms of the brakes tapping down on appreciation. As I have notated in the past, not all markets are created the same. Hence, real estate is incredibly “local”. Which is to say, that of the 384 MSA’s (Metropolitan Statistical Areas), they will vary greatly on positive and negative upside, but generally speaking, appreciation will come to a grinding halt. Referring to JP Morgan’s annual economic outlook for 2023, and in particular for commercial properties, “There may be an upside for multifamily owners and investors, as higher interest rates may cause potential homeowners to remain renters for longer.”
Commercial Real Estate Outlook
*My predications last year, where that – and I quote myself, “Industrial will remain hot.” For 2023, expect the same. Per the CBRE outlook, it’s a positive outlook despite deal deceleration and concerns about rising development costs.
*My predication for Multifamily in 2022 were for a hot market. For 2023, expect almost the same but not quite. As I peruse rental rates in major markets, the first harbinger for a “renters market” are the deal concessions and free rent. Surprisingly, or maybe not, I have not seen a lot of free rent deals based on a 1-year lease term. My thought? Give it time. Landlords are still a bit greedy at the beginning of the year, but much like any new year resolution, they’ll break that wish sooner than later. They’re only human. Once late payments and eviction notices heat up by Summer 2023, rental inducements will start to crop up in advertisements. I give it a lukewarm year for Multifamily residential.
*For retail in 2023 – and somewhat dissimilar to 2022, it will still be at a crossroads. After having not really fully comprehended the “new normal” created by the Plague in 2020 and subsequently not reducing square footage rental rates per market demand and what is commensurate with reality, retail commercial real estate brokers are truly dreamers. Some lessons are not easily learned, nor comprehended. Hence, and as in 2022, retail will continue an uneven roll.
*Philosophically, office brokers are realists, compared to retail brokers, who are idealists – and dreamers. Which is to say that commercial real estate in the office sector will continue to offer better and better concessions to the entire spectrum of tenants: from corporate behemoths to mom-and-pop bodegas struggling to make a buck in New York City. Nationwide, these deal concessions will keep the economy rolling in a positive direction, in that office tenants will at least be minimally ‘cash flow positive”, which is a good sign for everyone.
Author Bio: Writer D. Sidney Potter, former commercial real estate broker in Los Angeles, is seen on a recent Zoom call contemplating whether or not the US is headed towards another real estate recession in 2023.