Author: Allen Buchanan This post originally appeared on Location Advice and is republished with permission. Find out how to blog with us on theBrokerList.
As
we dawned 2022, yield on ten year treasuries was 1.73%. Also referred to as
T-bills – the rate today is 3.4%. Last week the rate eclipsed 4% for the first
time since last October. But prior to that, rates had stubbornly refused to
budge north of 4%. During the Federal Reserve’s loosening in the pandemic –
rates on ten year treasuries were below single digits. That’s right! In mid
2020, if you agreed to tie up your money for ten years – until maturity – you’d
receive a paltry .52%. Let’s say you were quite cautious, risk averse, but
wanted some return on your cash and bought a pile of these government issues.
If you planned to redeem the bonds in 2030 – no problem. The return would be
there, along with your principal amount. Let’s say for example you parked
$100,000 in this manner. You could expect your investment to yield $520 per
year for its duration. But. What would happen if you needed the principal
before the maturity date of 2030? You could sell the bonds on the market. But
at a steep discount. How much, you may be wondering? Using the yield of 3.4%
today, your principal would be worth $15,294! That’s a hit of close to 85%.
This very over simplified example is partially what caused Silicon Valley Bank
to fail and be seized by federal regulators. When the run on deposits occurred
last week – the bank was forced to take a loss on its bond portfolio in order
to cash out investors. Bonds move inversely. As the price of a bond increases
its yield decreases and vice versa. Capitalization rates on real estate behave
in a similar fashion. As cap rates increase – the value of the underlying
property decreases.
To the question above – what impact a bank failure might have on commercial
real estate – here goes.
Federal Reserve may not raise rates as aggressively as it planned. When
the federal reserve started its march toward a federal funds rate target of 6%
– in an effort to lower inflation to 2% – a series of .75% rate hikes ensued.
These .75% rate increases morphed into .25% rate increases early this year as
inflation showed signs of easing. We’ve now experienced a couple of months of
strong jobs numbers paired with increased wages and a resilient consumer who
refuses to stop spending. Before the bank shenanigans of last week, many
believed a .5% increase was in the works for the March Federal Reserve meeting.
However, because of the rapid increase in the Fed Funds rate – remember we’ve
gone from a half a percent to 4.5% in less than a year – some believe we could
avoid an increase altogether.
costs may increase. If
depositors believe certain banks are riskier than others, they’ll demand a
greater return on their money for the added risk. Read. Higher depository
costs. If failures cause a revamp of banking regulations – similar to what we
experienced in 2008 – reserve requirements might increase. The impact of these
two mean fewer, more expensive dollars to lend.
activity may slow. We
saw a dramatic decline in institutional investor activity in the second half of
2022. Left were private capital investors. Historically, this investor genre
will pay less than institutions. Primarily because they borrow money to affect
the buy. A classic disconnect is now occurring between buyers and sellers.
Unless there is distress on behalf of a seller and/or tax motivation on behalf
of buyers the dance ends before the band tunes up. I don’t see this ending
soon.
rates may be higher.
Expect higher cap rates because of all of the above. Keep in mind. A year ago
3.75%-4.25% cap rates were the norm. Traditionally reserved for the bondable
absolute net investments – such as Amazon on a ten year lease with 4% annual
rent hikes – capital, seeking return, was pouring in to anything with a truck
door. Many eschewed long term leases in favor of shorter terms where a rent pop
could be sooner realized. Now. The government will pay you 4.2% for a two year
treasury backed by the full faith an credit of the United States. Sure. You
don’t get the appreciation or depreciation of a real property investment but
the risk is minimal.
Associates Commercial Real Estate Services in Orange. He can be reached
at [email protected] or 714.564.7104. His
website is allencbuchanan.blogspot.com.
Allen has been a distinguished voice in the cre social media and technology community since he started his blog in 2010. Allen’s posts are published weekly in the Sunday Real Estate Section of the Orange County Register. Allen is the creator of the popular YouTube video series Tuesday Traffic Tips. Allen has been named to the prestigious Top Ten On-Line CRE Professionals List for the past 3 years.
You must be logged in to post a comment.
