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Commercial Real Estate values and transactions are dependent on economic conditions that affect businesses locally and nationally. Local economies vary but currently, Central Oregon is in a growth cycle. Following are some select trends that have the potential, if they persist, to affect business and commercial real estate in the near future.
Persistent Inflation and Interest Rates
Persistently high inflation is partly fueled by a high level of consumer demand. Josh Lehner, State of Oregon Economist, in his May 29 economic report says, “The U.S. economy remains in an inflationary economic boom.”
Consumer spending is a major player in the persistently high inflation rate. Consumer spending, also known as personal consumption expenditures (PCE), is a major component of gross domestic product (GDP) and a key indicator of the economy’s strength. In the first quarter of 2024, PCE accounted for almost 68% of the U.S. GDP.
Some economists recognize that the continued strength of consumer spending is coming from lines of credit. A survey by Debt.com on April 24, 2024 reported, “Thirty-five percent of Americans said they have maxed out their credit cards in recent years. Of those who had maxed out their credit cards, 85% said they were pushed to use their cards to the limit because of price increases from inflation.”
Approximately 22% of Americans said they now owe between $10,000 to $20,000 in credit card debt, and 5% have more than $30,000 debt. That means nearly 30% of Americans face five-digit, short-term debt.
Politicians talk about our robust economy and the resilient American consumer. The reality is this economic growth is courtesy of Visa and MasterCard. It’s not a sustainable economic trajectory.
Another reality in our persistent inflation is the large amount of government funds that have fueled the economy since COVID. According to recent U.S. Treasury fiscal data, Government spending is currently over 29% of GDP, or almost 40% higher than the historical average.
If these two conditions persist, inflation will remain high, and we will not see, in the near term, a decline in interest rates from the Fed.
In Commercial RE, high lending rates create an unfavorable gap between interest rates and cap rates. Cap rate is a ratio between Net Operating Income from lease revenues and the purchase price for the real property and indicates the level of investment risk.
Developers, investors and creditors demand an attractive cap rate.
Cap rates are low in Central Oregon, between 4.5% and 6%, because of recent high demand but banks will not loan when cap rates are lower than interest rates. A recent inquiry with local commercial lenders indicates commercial loan rates are currently over 7%.
Transactions involving 1031 exchange funds (IRS rules governing how investors can avoid capital gains taxes from real estate investing) and owner-carry are still options. But lenders will demand higher equity-to-debt ratios to make them comfortable.
Other Concerning Economic Indicators
Oregon’s job loss might indicate a declining economy. According to a first quarter 2024 report from the Oregon Office of Economic Analysis (OEA), the State lost 4,900 non-farm payroll jobs from January 2023 to January 2024. That translates to a growth rate of -0.2%. Oregon gained jobs in private education, health services industry and government.
Noteworthy is that Oregon’s government jobs grew at 3.4%, which ranked sixth nationally. But Oregon’s job growth in many other sectors ranked at or near the bottom of the list. Continuous growth within our federal, state, regional and local government sectors is not good news to Oregon’s economy overall. In Central Oregon, businesses’ and individuals’ property tax statements document what various government agencies require to meet payroll and other operating costs. This sucks capital out of the economy rather than adding to it.
Oregon is losing residents. Among all states and DC, Oregon grew at the slowest rate. The OEA report also says “The latest Federal census data shows Oregon lost 16,000 residents. This is the first negative growth in decades and the sixth fastest rate of decline.”
Negative growth and loss of employees are unfavorable signals for businesses, and these realities change the demand for commercial RE. Our State economy depends on business growth and those in Central Oregon will eventually feel the pinch.
Meanwhile, our local banks and lending entities are keeping a wary eye on maturing commercial real estate loans. These loans are shorter term than home mortgages. A normal term for a commercial loan is 7 to 10 years. Loans taken out during the economic boom after the 2008 recession — at attractive low interest rates — are maturing and will need to be renegotiated at higher interest rates.
High vacancy rates in office and retail along with high interest rates will affect lending ratios. According to some local lenders, refinancing CRE loans might be too risky for lenders without additional infusions of equity or a better revenue stream.
These economic concerns could evaporate quickly if the inflation rate is reduced. As recently as February, the market was predicted a 99% probability of a rate cut by last month. That didn’t happen.
Expectations have now shifted to a 72% probability of a rate cut by September. The Fed continues to target a 2% inflation rate as its goal. Any sign of a declining inflation rate will be good news signaling the Fed to consider interest rate reductions. That will bring relief for our local commercial real estate lenders and investors.
debt.com/research/credit-card-survey • Windermere.com • Barrett@Windermere.com
