Current market conditions, especially with cap rates having risen from the low 4s to over 5-5.5%, making values of properties down ~30%.
This is caused by recent shifts 0 => 5.5% in the Fed Rate (quickest time in history). To illustrate, a property initially valued at $60 million might see its worth decrease by 30%, settling at around $45 million.
Basics on Property Evaluation:
To figure out how much your commercial property is worth, you can use the following simple math equation. You take the money you make (NOI) and divide it by something called the cap rate. The cap rate tells you what people are willing to pay for properties like yours.
So, the equation looks like this:
Value of Property = Net Operating Income / Cap Rate
Imagine your shopping center makes $100,000 a year after you pay all your costs (that's your NOI). And let's say the cap rate in your area is 0.05 (or 5%). You can figure out how much your shopping center is worth like this:
Value of Property = $100,000 / 0.05 = $2,000,000
But here's the tricky part: You don't get to decide the cap rate, it's decided by the market, kind of like how fashion trends decide what clothes are cool. If the cap rate goes up because the market changes, like from 0.05 (5%) to 0.06 (6%), even if you're still making $100,000, your property's value changes.
So with a cap rate of 6%, it looks like this:
Value of Property = $100,000 / 0.06 = $1,666,666.67
Even though you're making the same amount of money, your asset's value went down because the cap rate went up. It's important to remember that you have control over making your shopping center nicer and more profitable, but you can't control the cap rate, which can make your property's value go up or down without you changing a thing!
It's a sobering situation that no one has faced since 2009 faced with it firsthand. The stark reality is that a 30% market downturn, again caused by an unprecedented surge in interest rates – the highest in four decades – can profoundly affect market values. Such a scenario doesn't just bring values down by 30% but also places substantial pressure on property holders, especially when debt refinancing looms on the horizon, compelling action at these reduced market values.
Here is the double whammy that increases the cash in refinance needed, the capital markets (bank lending) terrain has tightened greatly. Banks, previously granted loans at 70% of the property's value, are now capping at 50%. This adjustment demands a greater cash input at the point of refinancing. This is the debt renewal tidal wave everyone is talking about.
From a personal perspective, this period has been particularly taxing. Having invested significantly alongside our investors, often being among the first to contribute when things got difficult. Witnessing the dissipation of substantial (multiple seven figures) personal capital, especially in efforts to steer through these turbulent times, has been a sobering experience. It became very apparent in Q4 2023 as the market cap rates continued to deteriorate even more as pricing has not found a firm ground.
