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This week, I came across a fascinating article on a significant shift in investment trends.

https://www.siliconvalley.com/2023/05/16/real-estates-popularity-as-investment-tumbles-to-5-year-low/

The article discussed the results of a survey which showed a decline in the popularity of real estate investing among 1,013 U.S. adults, falling from 45% in 2022 to 34% in 2023. It’s worth noting that similar figures are likely to be seen in Canada.

Real estate has historically held appeal for many investors, but its popularity can and will plummet when aligned with a cycle of rising interest rates.

Unpacking the Underlying Issue

Post-Covid-19 events that unfolded globally (including government stimulus packages, global lockdowns, and supply chain issues) triggered intense inflationary pressures. Central Banks, like the US Federal Reserve, responded with rapid short-term interest rate hikes to curb inflation.

 

For instance, the US FED Funds rate saw ten consecutive increases from March 2022, skyrocketing from 0.25% to 5.25% – a 2,000% increase over 14 months.

Given the size of the US economy, which represents 24% of the global economy (note 1), other central banks had to follow suit.  The Bank of Canada, fearing capital flight and potential currency devaluation, mirrored the US FED’s strategy, pushing its policy rate from 0.25% to 4.25% – a staggering 1,700% increase in the same period.

These unprecedented short-term interest rate hikes significantly impacted bond markets and, by extension, mortgage interest rates for borrowers, affecting the viability of real estate investing significantly.

Consider an investor owning a building with a net operating income of $100,000. In February 2022, the property could support a refinance mortgage of $1,646,450. (Amortization 35 years, mortgage rate of 3.10%). Now, due to these changes, the property can only sustain a mortgage of $1,334,280 (mortgage rate increased to 4.66%) — a nearly 20% drop.  This drastic decrease in refinancing capabilities significantly dampens the enthusiasm of real estate investors, explaining the dwindling popularity of this investment avenue, particularly in robust asset classes like multifamily properties, the situation is compounded. Sellers in these sectors are typically disinclined to part with their assets unless they are offered a satisfactory selling price.

Unearthing Additional Issues

Undeniably, there are other factors at play contributing to the current real estate climate. Certain real estate sectors, like office properties, have experienced a surge in vacancy rates over the past few years. The rise of remote work culture among many companies has dramatically altered the landscape of office demand, subsequently affecting investors’ borrowing power. Similarly, the retail real estate sector has long been grappling with its own challenges.

The escalating competition from online shopping, amplified by the impact of the recent Covid-19 lockdowns, has forced many smaller retail stores to shutter or drastically cut down their sales volume.

The Path Forward

Despite these hurdles, the solution for real estate investors remains straightforward. Real estate continues to be a powerful tool for wealth creation and inflation hedge.

Its unique appeal: banks can lend against it, providing investors with the leverage needed to grow their portfolios.

 

In our inflationary environment that has started climbng since 2021, it’s more important than ever for property owners to enhance their property’s financial health. Property owners must treat each property as an individual business entity. Just as public companies strive to generate returns for their shareholders, so should real estate owners view their properties. By providing superior services and amenities to tenants, property owners can improve their property’s financials. Each incremental increase in net operating income directly elevates the property’s value.

Thus, regardless of interest rates or wider economic conditions, a proactive property owner can still thrive.

Note 1 source: https://www.visualcapitalist.com/u-s-share-of-global-economy-over-time/

Mikael Kurkdjian, the broker of record (AEO in Quebec) with Baron Realty and licensed real estate broker in the Quebec and Ontario markets in Canada. Mikael is also a multifamily real estate investor himself.

The market supply for available apartment buildings is at an all-time low. Or, should I say, sellable apartment buildings are.

We all know that the value of apartment buildings has dramatically changed since the rates have risen from the low two per cent range to the high four per cent range.

However, many potential sellers are still clinging to the idea that they can sell at 2021 prices, which is no longer realistic.

As a result, there has been a dramatic increase in the number of expired listings, which is damaging to both sellers and brokers.

Sellers must face new economic reality

For the seller, unrealistic price expectations deter serious buyers from putting forward reasonable offers. For the broker, an expired listing means no pay and reputation challenges.

Taking a listing at “any price” is not beneficial to either party. And apartment buildings – the safest real estate investment – should never remain unsold or expire at this rate!

As the market begins to respond to more stable interest rates, serious sellers are still present and there are many serious buyers looking to invest their cash.

However, the down payment in proportion to the loan has to make sense for both parties.

If you are a seller who has accepted the fact that your 2021 valuation is no longer accurate, there are buyers out there.

Buyers: Offer your “best price”

Similarly, if you are a buyer who is willing to buy at reasonable numbers, your seriousness toward the purchase price you put forward is more important than ever.

Private sellers take time to adjust to the fact that their building is worth less today than it was two years ago. Therefore, it is crucial not to put a deal under contract and start renegotiating.

Today’s sellers are less patient than before (since they feel they are taking a “discount” to begin with), and buyers should come in with their best price and close the deal without delay.

Remember, a seller who has come to terms with the current valuation of their building will not have patience for buyers “nibbling” at the purchase price for minor defects, like they may have in the past when the margins were much higher.

If you are a serious buyer in today’s market, we recommend taking a more proactive approach with brokers who are currently transacting, i.e. put yourself forward as willing and able to drop an offer quickly.

Even months or years after having a building expire, a seller may be weary of doing a proper listing process again, as that experience caused the seller time and effort and has surely incurred them emotional dissatisfaction.

Such sellers, either based on their personal experience, or by just observing the market, are much more likely to entertain a one-off deal from a buyer that has the proper reputation (or for whom the broker can, more-or-less, vouch based on previous transactional experience).

In general, if you are a serious buyer, do not underestimate the psychological impact the doubling of interest rates has had on the majority of owners/sellers of apartment buildings and tailor your approach accordingly.

Baron Realty specializes in matching buyers and sellers of apartment buildings. The author,

Ramona Ursu works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec. ramona@baronrealty.ca