Surging interest rates ripple through California commercial projects

Oct. 31—Rising interest rates that have already slowed the local home market are now spreading to commercial real estate, where Kern County brokers and investors worry the trend could hinder new projects — especially speculative developments still trying to get off the ground.

A series of recent rate hikes driven by inflation fears at the Federal Reserve has raised the cost of borrowing money. That combines with persistently high construction costs to make development projects more expensive for developers, and by extension, the tenants they hope to attract.

Several local investments have already fallen through as a result of that combination, said commercial property consultant and adviser Scott Underhill with ASU Commercial in Bakersfield. Developers, especially those involved in speculative projects, are closely watching interest rates for signs of how their investments will do.

"If the rent of tenants doesn't go up" to compensate for income lost to higher interest payments, he said, "the project doesn't get built."

Construction costs generally weigh heavier on a project's balance sheet, Underhill and others said. The difference is that interest rate increases are the more recent phenomenon, arriving long after inflation began raising costs related to building materials and labor.

Sometimes the effect arrives mid-transaction, said Executive Director Vince Roche at Bakersfield commercial brokerage Cushman & Wakefield. When that happens, the buyer may go back to the seller and ask for a lower price, which can cause a problem because the investor behind the development expects a certain return on its money.

"There's a psychological piece," Roche said. "A lot of investors just pause."

He added that the firm continues to negotiate with tenants lining up to lease space at the property that formerly housed the East Hills Mall. While keeping track of factors like interest rates, Roche said, "We're marching forward."

Speculative projects are far more likely to slow as a result of rising interest rates than developments designed to serve a specific user, said Senior Vice President Stephen Haupt at Colliers Tingey International. Developers taking on financial risk by building in hopes of attracting a tenant later "will think twice," he said.

That could pose a challenge locally in light of a recent surge in so-called "spec" developments taking place locally in industrial and office real estate. Such investments were rare until a couple of years ago, when strength in both classifications picked up during the pandemic.

Haupt said it remains to be seen how big a concern rising interest rates will become locally, adding, "I don't think it's going to affect any existing projects" under construction.

Principal Anthony Olivieri with Olivieri Commercial Group in Bakersfield emphasized interest rates are among a "triple threat" to local development, along with labor costs and supply chain disruptions that have made construction materials harder to come by. He said via email that all three are having an impact on local development, and that how they get mitigated "could have a profound impact on the success of a project."

Executive Vice President Bruce Davis at Bolthouse Properties suggested that the interest rate hikes were predictable given that previously low inflation and low interest rates were arguable unsustainable. "Frankly," he said, "we have been expecting this type of correction."

As the company works to finish its master-planned communities in southwest Bakersfield, complete with neighborhood retail centers, it sees higher interest rates as one of several challenges, including slower permitting and supply-chain issues. The unprecedented combination, he said, requires a long-term view as well as committed partners among contractors, suppliers, lenders, tenants and even buyers.

Senior Vice President Oscar Baltazar at Colliers said he doesn't see interest rate hikes hurting the local industry market much, primarily because of a lack of product. He said a client he's working with is moving forward with a $2.5 million spec building because so many buyers are looking that the investor worries the opportunity won't be around long.

A similar optimism prevails at local multifamily developer Sage Equities, where principal Anna Smith said by email demand is a bigger driver of long-term cash flow than interest rates. She noted California is 987,000 units short of rental units, while some economists have predicted interest rates will decline next year.

"We believe the strong underlying demand for housing will be a much more significant driver of long-term cash flow and asset appreciation than any short-term arbitrage of interest rates by transactional buyers and seller," she wrote, adding that Sage intends to hold onto the projects it develops for at least 10 years before selling them.

Chief Operating Officer Glenn H. Daughtery at Bakersfield homebuilder Froehlich Development took a similar view, saying by email that although decisions to buy a new home these days take a bit longer than before, a lack of supply will continue to drive business.

"We think that buyers' interest will increase at a rapid pace once they see some stability in interest rates and their cost of living," Daughtery wrote. "In the meantime, we're working on creative solutions with our brokers and lenders to help the buyers get into houses now."

___

(c)2022 The Bakersfield Californian (Bakersfield, Calif.)

Visit The Bakersfield Californian (Bakersfield, Calif.) at www.bakersfield.com

Distributed by Tribune Content Agency, LLC.