What is the state of industrial investing today? Are the rising interest rates affecting some properties? What can you do to fix this problem? Chad Griffiths, Partner at NAI Commercial Real Estate, has been working in the space for over a decade and shares his insights.
What is happening in the industrial world today?
My overarching investment philosophy, and I try to share this with as many people as possible, because I think it's just the healthiest way to look at real estate, is investing very long term, I would almost like to think that I have an infinite money timeline. There are some properties that I don't ever want to sell, they might go to future generations. Anytime I buy a property, I must be as comfortable owning this property in 10 years, as I am today. That type of mentality smooths out these aberrations that we're going through. I think that this is going to be a painful aberration but I also think this is going to be temporary. I don't see interest rates being able to sustain this high going much past 2023. All the governments that are sitting on so much debt, all the corporations, all the households, by design, they're trying to curb inflation by pulling the interest rate lever, but it's making everything very expensive. And I do think that they'll pull that lever too hard and before we know it, we're going to have recessionary pressure and that comes with political implications. It's very hard to get reelected for a politician if they're in a deep recession.
I think we'll start seeing all sorts of promises coming out this year, whether it's the other side saying, We're going to lower interest rates to stimulate the economy. And then the incumbents are going to say, We're going to do the same thing. I think we live largely in a political cycle more than an economic cycle because there are too many people pulling levers to try and get themselves elected. I don't think this is going to be long term in the grand scheme of most of our properties, we have one property coming up for a mortgage renewal next year, and then some more in 2024. That one that's coming up could cause some heartburn. We've owned that property for five years now, we've paid off a good chunk of the mortgage, we've cash flowed all the way through and we plan on owning that property for another 10 to 20 years. Looking back 10 years from now, there will probably be this noticeable dip where the economy looked worse. But in the grand scheme of things, the markets are always going to ebb and flow. For that patient long term money, I'm not concerned. There are scenarios for people in the short term, where there could be some pain in the near forecast. And those are people with mortgages coming up right away. Anybody that has a mortgage coming up in the next six months, you're going to be in for some sticker shock, compared to what you would have had whether you did a three, or five year term mortgage before, that could be painful.
People that have tenants coming up for renewal in properties that perhaps have some issues could also face some problems. The industrial market as a whole is pretty strong, especially important markets, they are at a sub 1% vacancy rate, I don't think that they're going to have issues. But older properties that might not even be industrial, without going off on a tangent, office space would worry me. I would be very nervous to own office space right now. Let's say somebody bought an office property in 2018 and got a 4% mortgage. Coming out of COVID, I'm fairly convinced that most office users are going to at least evaluate whether they need the amount of space that they have. I think a lot of companies will consider downsizing. Office potentially has more vacancy coming up, you'll have a downward pressure on your lease rates just because there's more overall vacancy. And you could potentially see a 250 basis point increase in your mortgage, that is not a good situation. For an office investor with their mortgage coming up this year, I'd be nervous. The last point that I make is, it's hard getting deals to pencil right now, interest rates have gone up, which is a 400 basis points now from the low, anytime the interest rates go up like that the market has to respond in terms of cap rate, or overall market valuation. And it still seems like a lot of sellers are stubbornly holding to their prices that they thought the building was worth in 2021. The reality is that there was a major impact on the market, and it hasn't caught up yet. I'm finding it very hard to get deals together, the bid/ask spread between buyers and sellers seems to be pretty high right now.
Absolutely, may God be with everybody that has a mortgage coming up next year.
What would you do in that scenario?
I would probably raise money to pay that mortgage for the next couple of years, borrow from whoever you may need to borrow. Even credit cards potentially, there are several credit cards that you do not pay any interest for a year, I would potentially do that. If I believe that the rates are going to be going down. Another idea is start selling, or looking at partnerships. We have to do what we have to do. It's also part of all the preparation that we all have been talking about over the last five years, that people have been thinking, The recession is around the corner. The people that have not prepared and bought at 4% cap rates with 20% down, that's not on us because the wise investors have been warning people about this. It takes a 10% vacancy to destroy a deal in a recession. If people do not underwrite for that...they should have done their homework. A lot of people benefited over the last five years, and the ones that kept being super aggressive, you might need to take some money out of the benefit that you got over the last five years and put into these deals that might be suffering for the next couple of years, in my opinion.