No I’m not crazy and I don’t subscribe to conspiracy theories.  But, as we speak the value of your commercial real estate is being “changed” by the federal government.  This is not a joke; the federal government is making your real estate value decrease.  How is this possible?  Both parties are responsible for the debacle that will drive down your value.

Deficit Spending

Both republicans and democrats have become the “spending” party.  This has resulted in huge increases in the federal deficit.  Don’t worry, I’m not anti-deficit.  Deficits are useful tools to stimulate the economy in recessionary cycles.  The current deficit spending is in an expansionary cycle!  This deficit has to be financed by the sale of treasuries.  As the deficit climbs more treasuries must be sold.  As basic economics tells us, as supply increases while demand stays constant, prices decline.  Recall interest rates move in inverse to treasuries so as the cost of treasuries decrease rates increase.

10-year treasury hits new highs:

As supply of treasuries has increased, the 10 year treasury recently approached new highs  The 10-year treasury represents an asset with little risk.   The 10-year treasury recently hit 3%.  This means that your return on a risk-free asset is 3%.

What does this have to do with real estate

The rise of the 10-year treasury has huge implications for real estate.   One primary method of valuing commercial real estate is the income approach.  The income approach takes the net operating income divided by the capitalization rate (the rate of return an investor requires).  The higher quality an asset the lower the cap rate.

Cap rates are not “set” by anyone; they are influenced by market forces.  As risk free assets like treasuries increase in yield as they are now, the market will demand higher “risk premiums” over the 10 year treasury.  For example when the 10 year treasury was at 2% a class A commercial property might have traded at 3% rate of return, this is the Cap rate (1% above the risk free treasury).  As the long term treasury rates increased, the market is going to keep the 1% spread above the risk free asset so the new Cap rate will be 4%.

Cap rates move inversely with value.  The higher the cap rate the lower the value.  Below is a table of what the change in treasuries means for a property owner.  On the surface, a one percent change in value does not seem like that big of a deal.  But just with the move in treasuries from 2 to 3% decreased the value of commercial real estate substantially.  Look at what happens if the 10-year treasury went to 6%.  Note the NOI is not changing.  We are not in an inflationary environment so rents are not increasing drastically for this analysis (in reality rents could increase based on inflation, demand, etc..)  Here is a link to the spreadsheet below so you can change the numbers to see the impact

 

Net Operating Income  $          100,000  $      100,000  $      100,000  $      100,000
10 year treasury 2.00% 3.00% 4.00% 5.00%
CAP rate 3.00% 4.00% 5.00% 6.00%
Value  $       3,333,333  $   2,500,000  $   2,000,000  $   1,666,667

 

Your value is declining due to the federal government!

In today’s environment inflation has been relatively modest and therefore rents increases are not keeping up with the moves in the treasury rates.  The impetus behind the recent increase in treasury yields has been driven by the increased supply due to deficit spending.  The federal government’s choices by both parties will have real impacts on commercial property owners.    The only remaining question is how much will property owners be impacted.

 

I need your help!

Don’t worry, I’m not asking you to wire money to your long-lost cousin that is going to give you a million dollars if you just send them your bank account!  I do need your help though, please like and share our articles it would be greatly appreciated.

 

Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

 

Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide.  To get started on a loan all they need is their simple one page application (no upfront fees or other games).