By Tom Bradley
Scott and I met with a client recently who owns a number of commercial buildings. He was telling us a story about his first purchase in the early 1980’s. Along with a few partners, he bought a building at a fraction of its value (in his opinion), but had to finance it with a 19% mortgage. Needless to say, they paid down the mortgage as quickly as they could. Looking back, it was a time of cheap assets and expensive financing.
I can’t help but contrast his story to the situation today, where real estate of all types is in high demand. There are no deals to be had, and certainly no distress sales. Indeed, capitalization rates have followed interest rates down to unprecedented levels (i.e. valuations have moved up). And today, buyers aren’t in a hurry to pay down debt, so profits can be used to fund more purchases. In other words, we’re in a period that’s exactly the opposite of the early 1980’s – expensive assets, cheap financing.
What concerns me about the current situation (and why I’m so cautious about real estate in general), it that the cheap part of the equation (borrowing rates) is transitory, as our client gladly found out, while the price paid is permanent. That’s a combination I like to avoid.
(Note: I suspect the buyers who are driving our summer surge in home sales are pursuing this combination vigorously. As least some of them have been motivated by a guaranteed mortgage rate that pre-dates the increases in June.)