COMMERCIAL REAL ESTATE: Is this the top?
Nationally, real estate has cycles. These cycles typically occur in 7- to 11-year periods and are the result of overbuilding and changes in the cost and availability of financing. In northern Michigan, values have always gone up. Well, not always, but most of the time since I’ve been involved in the real estate business in northern Michigan since 1971.
In all that time the market has only been down for one sustained time period, in the early 1980s. Even when the national economy was in recession in the early 1990s, northern Michigan’s economy was growing.
In the last three to five years, property values have been escalating at double-digit rates in many local markets. During the last few years many large offices, retail stores and motels have been developed. Since many of the offices are still under construction, it is not yet possible to determine if they will fill up quickly or languish on the market, forcing rents, and thus values, down. It looks like retail stores are being built on every available site, possibly overbuilding this sector.
Many rooms have been added to the motel market both on and off water, all around the region. Have too many motel rooms been built? Interest rates are up and it appears that they will go higher.
Does all of this mean that the trend of ever-increasing values in northern Michigan has come to an end? Or have values already started to trend down? Has our market become attuned to the national market, with a trend downward as the next phase of our cycle?
Higher interest rates generally mean lower values for income producing real estate. This is caused by investor return requirements. If investors require a certain return on their equity and the mortgage rates go up, thereby requiring more of the cash flow, then values have to come down. Given that investors have certain return requirements, considering the overbuilding along with recent increases in interest rates, values must go down.
I recently attended a real estate appraisal seminar in the Detroit area, attended by prominent appraisers from all over Michigan. I asked the class if they thought values were increasing or if they had they crested and were now starting to trend down. The majority thought that values were increasing, but a few thought that the crest had passed and values had already started to fall.
My philosophy has been to purchase or develop income- producing real estate for the long haul. The idea being to eventually pay off the mortgages and enjoy the cash flow as retirement income.
Has the time come to change my philosophy? Should I look at real estate as a commodity, like stocks? Should I sell now, get the price at the crest of the wave, then buy back into the market when values are low? If I do not sell now, will I have the money to purchase property when the market is down?
It is likely that our market will have some stagnant sectors in the short-term future. Should you and I sell our real estate now? That depends on many factors. I have fixed rate long-term mortgages and most of my tenants appear to be stable. I am staying in the market for the long haul with what I’ve got.
Should you sell yours? There is no one answer for everyone.
Michael Tarnow is president and a partner of Northern Michigan Real Estate Consultants, which specializes in the appraisal of all property types in northern Michigan and the UP. He holds the MAI and SRA designations from the Appraisal Institute. BIZNEWS