Commercial Real Estate - Not All is Gloom and Doom
By Leo Wells, President, Wells Real Estate Funds
In order to understand our current economic situation, you need to go all the way back to the start of the 2001 recession. At that time, the Federal Reserve took steps to begin lowering the federal funds rate - the short-term interest rate at which banks can lend money to each other. In fact, the Fed lowered the rate 13 times from January 2001 to June 2003, taking it from 6.5% down to 1%.1
An abundance of cheap debt caused the demand for housing to boom and real estate values to skyrocket. Unfortunately, much of this debt was in the form of adjustable-rate loans. When the Federal Reserve subsequently raised the fed funds rate 17 times between mid-2004 and mid-2006,1 the interest on these adjustable rate loans increased, and refinancing became increasingly difficult.
This mismanagement of debt ultimately resulted in a record number of home foreclosures, the demise and restructuring of many financial institutions, and a virtual freeze on available credit. The freeze on credit quickly spread beyond home loans to encompass commercial loans as well. The inability to obtain new commercial loans or to refinance existing loans has impacted virtually all areas of the U.S. economy.
What does all this mean for commercial real estate? For those who must engage in a transaction today, either as a landlord, borrower, or seller, the situation will generally be less favorable than 12 months ago. Tenants are demanding better terms, lenders are largely on the sidelines, and the combination of those things means buyers are paying less.
On the positive side, buyers who have cash potentially stand to benefit. Buyers with cash are actually well-positioned to prosper in today's environment, as many current owners may ultimately be forced to sell their best assets at bargain prices if debt service cannot be satisfactorily renegotiated. So for those who have pursued a prudent course over the years, there is potential for great opportunities.
1"Federal Funds Target Rate History," www.fedprimerate.com
