Growth in business sector keeps commercial properties in demand

Demand for commercial real estate is keeping the market hot, despite rising interest rates and the cost of construction supplies.

Mostly that is.

Representatives of Northwest Bank said securing financing differs for those who own the properties and third-party investors who lease properties.

And the office and retail center sectors are being hit the hardest as people continue to work remotely and shop online.

Abe Ibrahim, market executive, Northwest Bank, Delaware Valley, who deals with the commercial real estate market – properties owned by investors who lease to third parties – said since people are working remotely, there are a lot of vacancies in office space, a trend he sees continuing in the coming years.

Malls and shopping centers, he said, usually require a big-name anchor to draw people to the centers.

“They are not doing as well as they should and when the property value is on par with or drops below the debt owed, it’s hard to get refinancing when needed,” Ibrahim said.

When it’s time to refinance, Ibrahim said the declining value of the property “puts investors in the hurt.”

“They either default or have to right size the loan,” he said, which is based on rent rates.

With the high interest rates, Ibrahim said, many are choosing to sell at discounted prices or defaulting on loans.

Michael McCarty, C&I commercial market executive, Central/Eastern PA, Northwest Bank, said historically, when interest rates rise, there is a slowdown in real estate which affects values.

“I haven’t seen a slowdown except in office space and strip malls,” he said. “Companies are not slowing down.”

In fact, he said the manufacturing sector is still growing and because of the low vacancy rates, many are building.

Some, he said, are adding capacity in small chunks but eventually, that becomes inefficient as the business grows.

“The only way to continue to grow is to find a footprint that allows for enough space. If none exists, they need to build,” he said.

McCarty explained that when it comes to financing new or expanded space for business owners, the valuations and appraisals are not based on rents as is true in the commercial real estate side.

“We look at replacement costs or the value of the property,” he said. “The appraisals are driven by comparables of other properties.”

The decision facing many businesses, said Chris Flores, regional senior vice president, Northwest Bank, is when to expand space with the higher costs due to interest rates.

“You can’t stop growing your business, but the cost of expanding has to be taken into account,” Flores said. “So, the question becomes, do you lease or build.”

“Companies are challenged as they try to figure it out,” he said.

The three pointed out that two years ago, people were looking at 5% or even 4% interest rates, where today they are much higher at anywhere from 6.5% to more than 10%.

McCarty said business owners can qualify for the Small Business Administration (SBA) 504 loan.

The SBA 504 Loan program provides long-term, fixed rate financing for major fixed assets that promote business growth and job creation, according to SBA.

McCarty said a conventional deal will allow a borrower to get a loan for 80% of the cost of the project. With the SBA 504 loan, they can borrow 90%, which he said preserves capital.

He explained that the bank loans 50% and the SBA loans 40% at one point lower than the bank.

“The amoritization is 25 years fixed. The bank’s is 20 years,” McCarty said. “It’s a way to accomplish buying.”

“The 10% preserves working capital that allows companies to continue to grow,” Flores added.

Ibrahim said multiunit properties are still strong as millennials are “not bullish” on buying homes at the current rates.

“I’m a millennial and I never saw these rates,” he chuckled. “Now Gen Z and millennials are seeing these rates and choosing to rent and ride it out.”

That is good for investors in multiunit properties. If they can demand the rents, they build, he said.

Flores said he doesn’t think rates will drop to the historic lows of the past few years, but thinks as they stabilize, people will get back into the homebuying market.

“The interest rates are high, but there are still good opportunities, and we are still lending,” Flores said. “It comes down to relationship banking. When an investor comes to me and I’ve seen what he can do and how he works, it’s easier to approve a loan.”