A little encouraging news on inflation, but probably not enough to cause the Fed to change its course just yet.

The usual metric that is used, the Consumer Price Index for All Urban Consumers (CPI-U), actually decreased by 0.1% in December 2022, increasing by 6.5% from the previous year. This is a decrease from the 7.1% change year over year in November. Numerous publications claim that the decline was consistent with mainstream projections.

Overall, that’s a great indicator since it indicates that prices are actually starting to decline rather than merely slowing off. Things become more chaotic as you go deeper. Energy expenses decreased by 4.5%, which was mostly the result of dropping gasoline prices. However, the price of food, which cannot be disregarded, increased by 0.3% between November and December, which immediately puts a strain on the wallets of typical customers.

After rising by 0.2% in November, the core inflation index—which measures all goods except food and energy—rose by 0.3% in December. Inflation was even worse in this regard.Shelter, or houses and multifamily buildings, was a significant factor. In November, it had increased by 7.1% year over year, and in December, it had increased by 7.5%. Fuel oil (for buildings that use it to heat) and energy services both stood out in the 12-month price growth rate at 41.5% and 15.6%, respectively.

The Federal Open Market Committee is expected to raise the target range for the fed funds rate by 25 basis points at their upcoming meeting, Oxford Economics predicted in an email. “The December CPI is another small step in the right direction, but it doesn’t alter our forecast,” Oxford Economics said. The Fed will want proof that they have stopped inflation and that it is returning to their 2% aim, so this probably won’t be the last rate increase this cycle. The reaction to the December CPI in the financial markets and Fed Funds futures was rather modest.

And as Bill Adams, chief economist for Comerica Bank, said in emailed remarks, “Inflation should continue to decrease in 2023, allowing the Fed to suspend rate hikes this spring and begin to progressively cut rates in the fall.” However, the economy was already deteriorating towards the end of 2022, and in 2023 it would probably go through a slight recession.

One potential worry for the CRE housing sector is that housing costs continue to be a significant contributor to inflation and outsized growth. This may make customers angry and bitter, and it might even prompt requests for further control.

The current shift in many markets toward steady and even declining rents has an impact on multifamily investments and individuals who own apartment buildings.

In addition, landlords are in a unique position compared to other run-ups because inflation is currently rising faster than rents, which could provide difficulties for buyers when working with their lenders.
According to Jamie Berenger, chief credit officer at A10 Capital, the multi-family industry has seen a disproportionate amount of capital invested recently when compared to other asset classes. This sector is seen as a safe haven for real estate investment.

Buyers had to anticipate large, ongoing rental rate growth in order to “pencil” agreements,  according to the increase in capital-chasing transactions, she claimed. Should they materialize, a fall in rent growth predictions could lead to extended or, in more extreme cases, missed business plans.
A lack of rent growth will put pressure on stabilized (takeout) indicators, especially on transitional assets secured with bridge loans, which will create a divergence between lenders and borrowers in the future.

Rents are rising faster than expenses.

We are going to continue to see a cooling in the multifamily market, especially in the places that were overheated in 2022 (Florida, Tennessee, Nevada, Arizona, etc.).

Rents and sales will continue to decline as the economy continues to be affected by inflation and interest rates, which Bechtel predicted would likely continue until the third or fourth quarter before the Fed starts to taper.

I believe that a recession is already underway, particularly when you consider benchmarks like a flat or inverted yield curve, long-term U.S. Treasury bonds with a yield over 3%, and negative growth over the last two quarters.

Operating expenses will certainly increase due to inflation, which could have an effect on property values if the landlord is unable to pass these costs on to tenants in the form of higher rent.

In some circumstances, the increase in expenses is surpassing the rise in rent for the first time in many years, leading to a decline in NOI growth. You might observe rising capitalization rates together with declining sales, which could further decrease values.

Rent Growth Forecast is Being Reduced

According to a story this week by GlobeSt.com, at least two apartment rent analysis organizations recently lowered their projections for 2023.

RealPage has revised its effective asking rent growth prediction for 2023 downward to 3%, with rent movement differing considerably by asset type and by submarket.

Yardi Matrix anticipates all of that growth to occur in the first two to three quarters of the year and has reduced its apartment rent projection for 2023 downward to 3.1% from 3.5%.

Beginning in 2023, Los Angeles will face increasing challenges that threaten to prevent economic recovery.

According to information provided by a major firm, the office vacancy rate increased once again in the fourth quarter, while apartment rents decreased somewhat. Additionally, investment across all asset classes has slowed down due to increasing interest rates.

The L.A. commercial real estate industry is expected to undergo challenges as the economy responds to changes in supply, demand, and pricing going into 2023, according to said research. Difficulties in borrowing money lead to less expenditure, which lowers real estate values while the Federal Reserve keeps raising interest rates.

The Federal Reserve is slowing down the economy in an effort to combat inflation by raising interest rates, but it’s clear that strategy is starting to have an effect on commercial real estate. The market is showing rising vacancy and falling rents, with the exception of industrial rent, which has held steady. It’s predicted that in the new year, each type of property will face its own chances and difficulties.

Office
Landlords are reporting reductions in occupancy rates due to a larger migration to quality assets as well as significant cutbacks in the tech and media industries, which have for years been major drivers in L.A. Larger office tenants are cutting excess space and reevaluating overall workspace needs, but most experts are in agreement that the sector is still on a “slow path to recovery.”

Demand for office space decreased even as the vacancy rate increased 110 basis points from the previous year to 15.2 percent in the third quarter of 2022. At $3.48 per square foot, the average asking rent was just slightly lower (less than 5 cents) than it was at the beginning of the year.

The research stated that landlords will become creative in recruiting tenants to occupy unoccupied space, offering advantageous concessions including flexible lease terms, free rent, and tenant improvement allowances.

Multifamily
Multifamily vacancy increased somewhat by 10 basis points year over year to 3.7 percent in the fourth quarter following a spike in development. According to a leading local firm, typical asking rent decreased for the first time since the pandemic shutdown. This was still 3.2 percent higher than it was in 2017.

The report stated that the change in market dynamics and demand for multifamily housing will persist beyond 2023. Rising borrowing rates, escalating construction costs, and a sluggish economy will influence the rate of growth for multifamily units, which seek stability.

Retail
While the average asking rent increased over the same period, retail vacancy rates were unchanged from a year earlier at 5.4 percent in the fourth quarter, despite some businesses returning to brick-and-mortar locations.

It’s expected that retail will continue to evolve, with the majority of merchants holding less physical selling space in storefronts and more warehouse space for e-commerce, outdoor restaurant dining, and curbside pickup—a permanent change.

Using “seller financing” is one of the most popular ways to put little or no money down when investing in real estate. Although it may be one of the earliest “creative financing” strategies, it seems to be losing favor in recent years, largely for the reasons to follow. All things considered, seller financing out the window, though. Knowing how to use it efficiently in your business might help you close more deals faster and for less money. This post will define seller financing, explain how to use it, and discuss potential pitfalls.

Just as it sounds, seller financing involves the seller providing the financing. In other words, although legal title is transferred, the payment is sent directly to the prior owner rather than a bank, and the property owner serves as the bank.For instance:

I want to buy a specific investment property, but I don’t want (or am unable) to obtain typical bank financing. Although the seller wants $100,000 for the property, he or she is prepared to “carry the contract,” as investors say when they agree to finance a piece of real estate they own. The owner requests a $5,000 down payment and a $95,000 balance with a 30-year amortization period at 7% interest for a $632.03 monthly payment. I accept his terms, and, after performing my due diligence, I close on the property using a title company in my neighborhood. Then, in order to collect the monthly cash flow difference, I search for a tenant  who will pay $1400 a month to rent the property.

The seller in the aforementioned situation receives an excellent fixed interest rate on their investment, I get to purchase the home for only $5,000 down, and I never have to interact with a bank.What’s the catch, though? Why don’t these have greater appeal?

Why Doesn’t Everyone Use Seller Financing to Buy?

The due-on-sale provision, which is a legal component of practically every mortgage and provides the bank the authority to demand that the loan be repaid, in full, immediately if the property is sold, is a significant issue with seller financing that throws a kink in the whole plan.

You can now see why seller financing is problematic: since the property is being sold, it doesn’t work well if there is already a mortgage on the property. In other words, if you have a mortgage on a property and use seller financing to sell it, the bank may contact you and demand immediate payment or proceed with a foreclosure.

Will that occur?

However, keep in mind that the “due on sale provision” only gives the bank the RIGHT to do so, not a commitment to do so.The bank might approve of the arrangement and say nothing about it, or they might never learn. However, whenever you sell a property with a due-on-sale provision, there is a significant risk involved. I personally don’t dabble with the due on sale clause since I want to reduce the amount of risk I take when investing in real estate. So, how do I benefit from seller financing?

How, therefore, can the “due on sale” clause be avoided?

As noted above, the risk of using seller financing when the seller already has a mortgage is that it may result in the “due on sale clause,” which could result in the property being foreclosed upon if you are unable to repay the bank the full loan total. In the event that you purchase a home from a homeowner, both of you would lose the property if the homeowner went into foreclosure. There is just one straightforward remedy because, obviously, you do not want to find yourself in this situation:

Use seller financing only if you have free and clear title to the property. (There are a few exceptions; we’ll discuss them later.)

In other words, if the property owner currently owes money on the house, you shouldn’t use seller financing to acquire it from them unless you first settle the debt. To purchase with seller financing, you must locate sellers without a mortgage. In this manner, they can offer the financing without having to worry about facing foreclosure.

The Advantages of Seller Financing
Let’s look at a few of the most frequent perks of employing seller financing, but there may be many.

1. 1. Ease of Financing: As was already noted, using pure seller financing eliminates the need to work with a bank, which for many people can mean the difference between a sale and no deal. Seller financing is a fantastic weapon in your toolkit if you have “tapped out” on the number of mortgages you can receive and need to buy more investment property.
   2. Due to the fact that you are negotiating with seller directly, there are no black-and-white regulations regarding the down payment. As opposed to Fannie Mae or Freddie Mac, who demand 20% to 30% down on investment properties, you are not subject to their strict requirements. As an alternative, you agree on a price with the seller. You won’t know until you inquire and negotiate what the seller wants in terms of a deposit, whether they want nothing or 50%.

• The rules when dealing with banks can be very rigid, but not with seller financing. This leaves room for creativity in transaction structuring. You might think outside the box to find a solution to a problem with seller financing. Rate, period, payment sum, due date, and every other aspect are all subject to negotiation, which can transform a fair deal into an excellent one. Speaking of being inventive, I’ve seen investors work out 0% seller financing terms with the seller.

1. 1. Purchase “Unfinanceable” Properties: On occasion, a property’s condition could be too bad for conventional financing. In these circumstances, seller financing may offer the buyer the opportunity to acquire the property, make repairs, and subsequently refinance into a more conventional form of financing.

• Doesn’t Show Up On Your Credit Report: Chances are that your seller-financed agreement won’t land up on your credit report, which can make it simpler to get additional loans and mortgages in the future, unless the home seller joins up with one of the credit reporting agencies to report the debt (which is extremely rare).

• Monthly Income: Obtaining a monthly income is probably the main reason why sellers choose to use seller financing. Many people would simply prefer to receive regular checks each month rather than a single lump sum, just like in the scenario I presented above with the $100 or $1 per month. For older sellers who depend on monthly income to make ends meet and pay the bills, this is especially true. For an older seller, a $100,000 lump sum would only last them so long. However, if that income is financed over 30 years, it will last them much longer until retirement.
• Better ROI: Because the interest they receive from the financing is higher than they are likely to receive elsewhere, many homeowners and investors choose to sell with seller financing. For instance, if a homeowner sold a property for $100,000, they had the option of investing the money in a bank’s Certificate of Deposit to earn 1.5% APY or seller financing their home to earn 8%. What is superior? This idea is well understood by many seasoned real estate investors, who eventually transition their portfolio from a “holding” phase to a “selling phase” by using seller financing to eliminate the hassles of ownership while continuing to generate monthly income by carrying the contract and offering seller financing. The investor then transitions from the “landlord” company to the “note buying” industry.

1. 1. Spread out taxes: The government always wants a piece of your earnings, and selling real estate is no exception. Due to an IRS provision that exempts homeowners from paying taxes on up to $500,000 in profit from the sale of their principal residence provided certain requirements are met, this issue may not be as crucial for homeowners. Investors, on the other hand, are less fortunate and must pay taxes when they sell. For instance, if an investor pays off a rental property mortgage over the course of 30 years, becomes the owner free and clear, and decides to sell the property for $100,000, the investor would be responsible for paying taxes on the $100,000, which might result in a tax payment of close to $50,000. A “recapture of depreciation” tax that the investor will also be responsible for paying might substantially increase that tax bill. As a result, many investors opt to sell using seller financing rather than receiving a lump sum payment in order to postpone the majority of those tax payments. The seller may only have to pay a small fraction of that tax payment each year while the loan is being paid off because the IRS has specific tax regulations for installment transactions, such as those involving seller financing. This brings up the “ROI” issue once more. If an investor sold a property for $100,000, they might lose as much as half of that—or more—to taxes, leaving them with only $50,000 to put toward other investments. Even if they were to make 12% on the stock market, they would only make that on the $50,000 they sold, not the $100,000. They will, however, actually make more money if they offer seller financing at 8% because the interest they receive is on the “pre-taxed” interest.

• Can’t Sell Otherwise: As was said in the section before, many properties are just not marketable to a regular borrower with bank financing. By providing seller financing, a seller may be able to sell a home without having to make the necessary repairs.

Although seller financing might give you as a buyer some great possibilities, you should be aware of the risks and hazards associated with the tactic. This section will examine three of the most frequent worries when dealing with seller financing and provide some advice on how to avoid those potential issues.

1. The “due on sale” clause has already been discussed in great detail, but I feel compelled to recapitulate it here. You must fully comprehend the meaning of the due on sale clause and why it is significant. By attempting to go around this provision, you don’t want to jeopardize your credit or your connection with the vendor. Be aware that if you use seller financing to purchase a home and the property has a mortgage with a due on sale provision, the bank may foreclose on the seller, placing you both in a difficult financial situation. Again, the most straightforward answer is to limit the use of seller financing to assets that are owned free and clear. I only have short-term finance as an exception to this rule. There are investors out there who use seller financing with existing mortgages (often called a “wrap” because you wrap one mortgage over another) despite the due on sale clause because they think they can fix the property up quickly and either sell it or refinance it before the bank finds out and has an issue with it. I won’t advise you to do this; that is up to you and your level of risk tolerance.
2. Higher Interest Rates: Although seller financing encourages tremendous innovation, you will generally pay a higher interest rate than usual.Though some investors negotiate 0% interest seller-financed loans, it is difficult to convince a seller to accept such a low interest rate in today’s lending environment with loans under 4%.Just be sure to run the numbers with the interest rates you plan on obtaining and make sure they work for the deal.
3. Fewer Potential Properties: Although seller financing can be a fantastic win-win situation for both sides, the vast majority of homeowners are either unable (due to existing mortgages) or unwilling to carry a contract and provide seller finance. Therefore, when trying to cooperate with seller finance, the pool of viable offers is substantially smaller.

We’d like to reiterate that seller financing does not justify overpaying for a property, even if it allows you to purchase properties without utilizing a bank. Only when leverage is used appropriately does it remain leverage; otherwise, it simply turns into a liability.

By the end of 2023, Fitch Ratings projects that the US CMBS loan default rate will have risen from its October 2022 level of 1.89% to between 4.0% and 4.5%. The firm cites increasing interest rates, ongoing inflation, and sluggish economic development as factors, with a minor recession beginning in the middle of next year.

According to the company, Fitch forecasts increased delinquency rates for all key property sectors next year. Multifamily, office, and industrial rates will surpass their previous peaks, according to the prediction. Retail and hotel prices, which are already the highest of all property kinds, will rise much further.

According to the estimate, many more new delinquencies, in particular maturity defaults, are expected. Due to the same variables that will increase defaults and distressed sales, as many in the CRE industry have been telling GlobeSt.com: greater refinancing costs, pressure on CRE fundamentals like rents, and rising cap rates, special servicing will still exist but at lower levels. The debt loads on a property undergoing a refinance will be larger, and there may be a requirement for less leverage, necessitating the need for extra funding from investors. However, rent growth has generally slowed down, and it typically fails to maintain prior net cash flows.

All major property categories will see an increase in delinquency rates. The highest-priced property types, retail, and hotels, will see further price growth, while multifamily, office, and industrial prices will rise above their previous peaks, according to a report by Fitch.

Retail, in particular, will be pressured by inflation and sluggish wage growth, which will impact consumer spending and the capacity to pay rent. In addition, Fitch predicts that numerous Class B and C mall loans that are coming due will default.

Hotel delinquency will rise, although Fitch doesn’t anticipate it to reach its 18.4% epidemic peak. For 2023, the agency stated that forward room bookings and pricing projections are high, supported by growing group room nights and healthy leisure demand. A recession will further postpone [the final recovery to pre-pandemic performance] even though 2023 is not likely to match the strong rebound of hotel performance measures in 2022.

With hybrid work arrangements, reduced demand for office space, rising expenses, and tenants moving to higher-quality workplaces, older and lower-quality B and C properties in the office sector are at the highest risk of default.

When compared to other types of housing, multifamily is in comparatively excellent shape since property prices and consumer mortgage rates prevent many people who otherwise would have bought a home from doing so. But as costs increase and rents remain stable or even decline over time, cash flow will deteriorate.

While still in demand, industrial tenants will notice a slowdown in rent increases as a result of the recession’s impact on business as a whole.

When it comes to economics and finance, it’s all too common for past patterns—specifically correlations like the one between yield curve inversions and impending recessions—to be taken as unbreakable natural laws. That could result in serious risks and strategic errors.

When the yield curve inverts, with interest rates on shorter-term bonds higher than those on longer-term bonds, a recession usually, though not always, occurs within a year or two. The “market” as a whole believes that the economy will slow down in the long run, which is why the Fed is cutting short-term rates to avoid a recession. Because they won’t get as much money from reinvesting when bonds mature because rates will be lower, they require higher interest rates on short-term bonds to make up the difference.

Although recent yield curve inversions have been observed, speculators have pointed out a number of potential confounding variables. Short-term Treasury bond rates have increased more quickly than longer-term ones as a result of high inflation and the Federal Reserve’s swift interest rate rises in response. The Russian invasion of Ukraine, rising discontent, and protests in nations like Iran and China are all examples of geopolitical turbulence that prompts investors to seek out safer places for their money, such as 10-year US Treasury bonds, driving up prices and returns down. These pressures, according to speculators, are pushing rates in opposite directions and causing an uncommon inversion type.

Be that as it may, markets are gatherings of people, and people have emotional reactions to things. Mechanical stresses coming from two directions that cause inversion and recession fears won’t just go away on their own.

For instance, analysts of this data could claim that there had not been an inversion between the three-month and ten-year bonds after conducting the research. That’s not the situation anymore. According to reports from the Federal Reserve Bank of St. Louis, the 3-month yield has been higher than the 10-year yield for weeks. The 3-month/10-year inversion has predicted a recession in 7 out of 9 recessions between 1957 and the Great Recession, according to Christopher Waller, who is currently a Fed governor but was the St. Louis Fed’s director of research at the time of this 2018 presentation.

What about the global economic crisis following the coronavirus outbreak? 2019 had an extended period of a 3-month/10-year inversion.According to Duane McAllister, senior portfolio manager at US firm Baird Advisors, consistent inversions like this one has been a fairly accurate predictor of impending recessions in the past.

If the Atlanta Fed’s early indicator is accurate and the annualized GDP growth for Q4 is actually 4.3%, economic growth appears to have returned. Despite high-tech layoffs, labor markets have remained strong. It doesn’t appear that the Fed is prepared to lower rates.

The signs might not be 100% accurate, but ignoring them could be dangerous.

Expect the Federal Reserve’s latest 75 basis point rate hike to have little effect on the commercial real estate transaction volume, which is already down year over year.

According to new analysis from Marcus & Millichap, trading activity in recent months has fallen short of but is near same-quarter figures in 2019. However, according to the firm’s analysts, the compounding impacts of numerous interest rate hikes have made it increasingly difficult to conclude commercial real estate purchases. This constancy will help investors come to an agreement and close deals more readily if interest rates stabilize at a new, higher level, the author writes.

The Fed will probably wait until there is solid evidence that inflation is returning to the 2 percent objective before putting a stop to rate hikes, which leaves the door open in 2023. Experts in the CRE industry believe this is when the rate increases will end.

In this new climate, higher cap rate properties are doing better than others, such as hotels, which traded over the last four quarters with first-year returns in the low-8 percent range. Although hotel financing premiums are frequently higher, the company claims that performance gains are lowering investors’ perceptions of risk. Only 30 basis points separated the national occupancy rate for the year ending in September (62.2%) from the long-term mean, while average daily prices in September increased by 17 percent from the same time last year.The American Hotel & Lodging Association and Kalibri Labs predicted this month that the US hotel industry’s overall revenue will surpass 2019 levels by 14%, or over $12 billion.

With cap rates recently dropping into the mid-seven percent range, senior housing also offers relatively strong yields. And the deals are coming in thick and fast: in the first seven months of 2022, Walker & Dunlop sold $1.3 billion worth of senior housing and long-term care facilities, breaking all previous records. However, experts predict that labor concerns and increased operational expenses will continue to be challenges for the sector.

According to Julie Ferguson, executive vice president and senior living at Ryan Companies, the ownership and financial structure of a company [may affect] whether they’re able to manage through a fall in operating margin. There will be owners who, if their lease-up is not proceeding as planned or if their expenses exceed their budget, will not be able to contribute further working capital to projects. Given the numerous factors that go into these choices, it is difficult to predict whether there will be more or fewer of them in 2023.

The SVN Vanguard team can help with your Commercial Real Estate needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing a sale leaseback? Contact us.