Interest Rate Spike Could Stall Industrial Building Buys
By MATHEW PADILLA
The recent spike in interest rates is affecting more than mortgage refinances and home loans.
The spike has sent a ripple through the industrial real estate market, worrying some that robust sales of small industrial buildings could come to a halt.
To be sure, brokers say that sales of smaller industrial buildings under 30,000 square feet, and especially those between 5,000 to 14,000 square feet, continue at a healthy pace. But rising rates are causing investors to take a second look at future buys.
“Interest rates are definitely signaling to the market right now that … we very likely have gone over the top of this roller coaster market,” said John McDermott, national director of office and industrial properties in the Irvine office of Sperry Van Ness.
Prices for commercial real estate are higher now than they have been in years, McDermott said.
“More people have been able to buy because money has been cheap and plentiful,” McDermott said. The expanded buyer pool of recent years,a result of interest rates at generational lows,has led to price appreciation, he said.
But rising rates threaten to change all that.
That’s because high prices, coupled with rising costs to borrow money, stand to result in smaller returns to investors.
Investors only will accept a lower return on their money if they don’t have to pay a lot for the debt they use to finance a deal, brokers say.
The impact could also be felt by business owners who buy industrial buildings and then lease them to their own companies.
These buyers often tap Small Business Administration loans, which generally are adjustable rate loans that become more costly as interest rates rise.
But unlike home mortgage loans, Small Business Administration rates haven’t spiked since mid-June, according to Gladys Bustos, an SBA loan sales agent at U.S. Bancorp in Orange.
Bustos said SBA loans are based on the prime rate, which has remained steady at 4% for several months.
The prime rate moves with the Federal Reserve’s fed funds rate,the interest rate charged to the nation’s banks. The Fed recently decided to keep the federal funds target rate unchanged at 1%.
The prime rate, meanwhile, hit 9.5% as recently as January 2001. It is the average rate that banks charge their best,or “prime”,customers.
Bustos said a client with good credit can get a SBA loan from U.S. Bancorp for about 1% over prime.
There are 15 small industrial development projects under development in Orange County, according to a report by Grubb & Ellis Co. Each project could contain anywhere from 5 to 11 buildings, ranging from 5,000 to 14,000 square feet each.
Kurt Strasmann, Grubb & Ellis’ top OC official, said that the number of small buildings for sale recently completed, under development or planned in the county is about 300, including office properties.
Strasmann said prices have been stable, but he recognizes the risk that rising rates pose.
The reason why sales are continuing is that rates still are near the rate they were a year ago when sales were brisk, according to Steve Case, senior managing partner with CB Richard Ellis Inc.
Case said as long as interest rates “stay within the realm they are in now, we should be in good shape.”
George Economos of NAI Capital Commercial said that sales are brisk, but “another round of hikes would affect everything.”
Brokers say even one more percentage point could spell disaster.
Still, Sperry’s McDermott expects sales to continue strongly for the next several months.
He said that there are many investors who have sold an industrial building and need to buy another to avoid paying taxes on their capital gains under the 1031 tax code. The backlog of 1031 buyers could last another six months, he said.
On the flip side, the picture is hazier for industrial leasing as a result of job losses in the county’s manufacturing and warehouse sector. Brokers say the market remains soft, though the second quarter was better than the first.
The county’s unemployment rate rose to 4% in June, up from 3.7% in May. The jump came as more people were looking for work here. OC’s rate compares favorably with California’s 6.7% and the national 6.5% rate.
A dearth of new industrial projects in OC has kept the vacancy rate for industrial space much lower than for office.
The county’s industrial vacancy rate actually decreased slightly from 8.7% in the first quarter to 8.6% in the second quarter, according to a Grubb & Ellis report.
The tightest market is West OC, with a vacancy rate of 5.6%, according to Grubb & Ellis. That compares to 11.9% in South County.
The vacancy rate for low-rise office space was 16.2% in the second quarter, up from 15.8% in the first quarter.
Landlords of all types can expect to face several challenges, including “the competitive supply of both direct and sublease space, highly competitive concessions and downward pressure on rents,” according to a Grubb & Ellis report.
