For the most part, Metro Denver commercial real estate owners and investors have the luxury of waiting out a short-term economic downturn since markets here have been, and will likely remain, relatively strong compared to many areas of the U.S.
Rising Federal Reserve interest rates haven’t significantly impacted commercial real estate deals and markets yet. We have every reason to believe that even if the Fed continues its attempts to slow the economy, markets here will only decelerate, not necessarily decline.
The rate of commercial real estate (CRE) price increases we saw in 2020 and 2021, especially in industrial properties, clearly has slowed at this time. But a CRE owner-occupant can still lock in and realize recent increases in their property’s value (without disrupting their operations at that site/facility) through a sale-leaseback transaction.
Recent actions by the Federal Reserve Board appear to be on their way to having the intended effect – an economic slowdown, especially in the commercial real estate (CRE) market. The Fed’s Board of Governors has raised the federal funds policy rate by 225 basis points since the first of the year to 2.5% and that rate may reach 3.5% or higher by year end.
Let’s look at some of the national CRE implications of these rate increases before we zero in on what really matters – the Metro Denver market.
Slowdown in Commercial Construction and Transactions
Higher interest rates increase borrowing costs and, therefore, CRE construction project costs. These increases are coming on top of the higher costs already factored in over the past two years related to labor shortages, supply chain bottlenecks, and the cost of building supplies in general.
Is the U.S. in a recession? Whether the correct answer ultimately proves to be “yes,” “no,” or “not yet,” it’s an academic issue that’s not keeping us up at night.
There’s no doubt, though, we’re entering a period of economic slowdown in the commercial real estate market caused by:
Whenever Washington politicians act like they’re serious about deficit reduction or tax reform, certain revenue-raising proposals find their way onto lists of proposed policy changes.
One of their recent favorites is the idea of limiting or removing altogether the ability of commercial property owners to defer capital gains taxes on real estate transactions, a practice known as 1031 exchanges, thanks to the provision’s home in section 1031 of the IRS tax code. You’ll also hear these referred to as “like-kind exchanges.”
Simply put, and with the understanding that there are many caveats and compliance details, a 1031 exchange is a process that under certain limited circumstances allows a commercial property owner to defer paying capital gains taxes at the time they sell a CRE investment property.
With interest rates steadily climbing, we’ll likely see the commercial real estate investment markets cool off, along with more parity between office space opportunities (the sector has struggled of late) and industrial space investment activity (which has been hot for several years).
However, interest rates shouldn’t be the only factor in a CRE investment decision, of course. Location and industry-specific trends (e.g., the life sciences boom in the Denver-Boulder corridor) also help determine demand, supply, and therefore the market price of a property.
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