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In June the Fed raised interest rates by 75 basis points in an effort to mitigate rising interest rates. That short-term uncertainty has diminished, however, with that, short-term costs will be high. The commercial real estate industry will be more impacted by long-term interest rates from the 10 Year Treasury, which was at 3.4 percent as of mid-July and within range to exceed 4 percent by the end of 2022.
Managing Director, Gene Williams, MAI, CCIM of Valbridge Property Advisors | Northern California shared some commentary on the office and multi-family market in the San Francisco Bay Area and outlying regions, which our firm appraises with regularity.
Market participants will likely execute very few transactions this summer – probably well into Fall if not early next year. Debt rates are increasing rapidly and a many pending sales have fallen out of escrow while buyers were seeking financing. We are aware of a very well-leased ~90,000-square-foot Class A office property in Santa Clara which was taken off the market after its sales team was unable to find a buyer at a price that was even close to their goal.
One of our industry partners is under contract to buy an apartment complex in the East Bay – this individual scored a 5% discount for the higher loan rates from the seller, but opined it should have been more. Deals with 20% discounts have fallen out of contract as lenders changed their rates in the middle of underwriting. Investors are still bullish on the multi-family market in the San Francisco Bay Area; however, Sacramento and Central Valley regions are poised for correction as the Bay Area exodus dies down. In addition, rents in Sacramento and Central Valley are closely tied to home prices, which are also expected to go through a correction in the near-term.
Market participants will only see the best properties trade in Q3 and Q4 2022. High-quality tenancy with long-term leases remain the most sought-after investments. We are aware of a pending sale of an office project in Sunnyvale with a AAA credit-rated tenant that is selling for about a 5.0% to 5.25% cap rate – approximately 100 basis points higher than about six months ago.
Investors and lenders are not so interested in the Bay Area multi-tenant office (with the exception of Palo Alto) due to increased risk aversion. Lower-quality properties that can be assembled into something over 1.5 acres (older walk-up office buildings) likely will reflect land value for multi-family or mixed-use development. Investors may see cap rates for these two property types in the 7.0%+ range very soon.
Finally, we will see a lot of creative financing when deals do close. As appraisers, we are prepared to get out that old cash equivalency spreadsheet. We’re going to see seller financing, loan assumptions, wrap mortgages, etc. One Valbridge client, a private equity investor is doing Mezz equity at rates between 10-12% for combined LTVs up to 65%. This is for projects that they could barely get an 8% IRR on six months ago, going all the way up the capital stack to 85% LTV.
The media insists that the economy is in trouble, however, we’d like to remind our readers not to panic. Inflation is no fun for anyone and yes, it’s going to hurt in a variety of ways, but employment and wages are still very strong. Consumer demand has remained strong, although there are indications it may be waning. But stagflation – the coincidence of weak growth and increased inflation – is not good for any segment of the economy.
In the Bay Area, there are very few sellers who need to sell. There remain plenty of buyers, but the bid-ask spread has widened dramatically. The markets will have to settle down and adjust. Here at Valbridge Property Advisors | Northern California, we are keeping a watchful eye on market activity and what that indicates for our clients’ property values.
Looking for an appraisal for transaction financing or valuation related to other market activity? Contact Gene Williams at email@example.com or use the form below to contact us.
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