The New Normal

Until late last year investors in Industrial Real Estate were very used to low interest rates, ample liquidity, low vacancy rates and rising asset valuations.

However, much of that has now changed.

Thanks to quantitative easing, we have inflation- which has resulted in rapidly rising interest rates in an attempt to cool said inflation. Much of the formerly readily available finance has dried up. Increased interest rates have increased expectations of yield – which has reversed the asset valuation trend. About the only metric that hasn’t changed is the low vacancy rate – for the moment.

So, what is the new normal?

Our view is that the new normal is very much a work in progress. While we wait for resolution on what normal might now mean, most parties are sitting on their hands and doing precisely nothing.

The industrial market is in dramatic contrast to the residential market, but is influenced by it, and dragged down by it, for two major reasons. The residential market has a lot of hurt to come for most who borrow to finance either their home or their investment.That hurt is not just because of increased interest rates – but because of the proportion of borrowing relative to the asset size. Whereas most industrial investors financing through debt will only borrow to a maximum of plus or minus 50%, the residential borrower is likely to be borrowing plus or minus 80% of asset value. Which means that generally industrial investors are impacted to a lesser extent by increased interest rates. It stil hurts – just not to the same extent.

There will not be carnage in the residential borrower space. Our view is that banks will manage delinquent loans by stretching terms, and interest only holidays, rather than mortgagee sales. Anything to avoid the bad press mortgagee sales would bring.

Nevertheless, managing the problems with residential loans is already spilling over in industrial lending. Banks are not only ratcheting up business interest costs, but also taking longer to address applications, asking for more information- repeatedly, and ultimately being more reticent to lending.

It doesn’t necessarily make a lot of sense as residential and industrial real estate lending are very different products. But unfortunately the knee-jerk reaction to difficulties in one area has a reflexive response in the other.

We have our own ideas (and the reasons why) on where and when interest rates will top out and then decline. But for many investors the uncertainty of not knowing is causing them to wait and reflect. Or, to put it another way, do nothing.

The current market is awash with listings, at least compared to three months ago, but almost none could be classified as “fire sale”. There are vendors with expectations of last year’s prices. And there are buyers who are waiting / hoping for desperate sellers.

And the end result is – nothing. At least, very little in the way of transactions. We recently had the reasons for this market stalemate succinctly explained to us: “No one knows what is a fair price. Buyers and sellers have different views”. Simplistic - but accurate.

The TradeMe ads are attracting very few phone calls. And what is surprising is that those agents who are waiting for silent phones to ring are largely doing just that – waiting – rather than being pro-active.

It will be fascinating to see the trigger that eventually forces vendors to be realistic that prime yields are not going to be 4% again for many years (if ever) and buyers to realise that for there to be fire sale prices there needs to be a conflagration.

And likely we won’t see any of that until the Rugby World Cup and the general election are dispensed with.