In the third quarter, we learned that inflation has slowed with CPI finding a new normal in the 3.5% range, about 1.5% above the “target” rate. “Higher for longer” is becoming an almost universally agreed-upon axiom. What does this mean for office and industrial owners? Most likely, cap rates are not going back to the extremely seller-favorable levels seen in 2021 for at least 18 months. Today, 5 five-year fixed rate debt costs roughly 7%. We expect rates to hold in that range for the immediate future. This actually creates an opportunity for buyers who can source deals in today’s scarce market. Anyone buying today will most likely have an opportunity to refinance in the next 3-5 years at a rate no higher than 5%. On a seven-cap acquisition, that refinance will represent a 76% increase in cash flow (assuming a 5% refinance and unchanged NOI). Inflation that is already slowing indicates that we are likely not to see an event with astronomically high rates like that occurred in the 1980s.
Industrial tenant demand continues to outpace supply, especially for spaces under 75,000 SF. We have put three properties under contract with owner-occupants at price records in the past two months. High-quality space located near transit corridors is starting to shine compared to C/D class properties in lower-quality locations. Small Bay, defined at units under 10,000 SF, is a particular high point. The space is starting to become more institutionalized. The $50+ million sale on Finnel Drive in Weymouth is indicative of this institutionalization of the product. We remain very bullish on this product.
Looking ahead to the 4th quarter and 2024, we expect to continue to see a market with depressed velocity. This is primarily caused by high current interest rates standing in sharp contrast to the rates many owners secured in 2020-2022. We are already having conversations with owners needing to refinance in late 2024-2026. The owners we are talking to are not in distressed situations. Many however face situations with massively lower cash flow projections upon refinancing at higher rates. This cashflow compression will most likely move some potential sellers off the sidelines, creating inventory. We recommend all owners run refinance projections for any properties with debt maturing before 2027. Our team is happy to help with this analysis.
In the third quarter, The Klein Group listed seven warehouses and two office buildings for sale, closed five transactions, and placed four properties under contract. Zero of these transactions are distressed or sellers that “needed” to sell.
Feel free to reach out to me to discuss the market, refinancing scenarios, or the value of your property.
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