Concerns about rising interest rates and the health of the economy have prompted real estate investors in California and around the country to reconsider their positions and pull their money out of commercial property funds. After announcing that withdrawals from its $69 billion real estate investment trust had exceeded expectations, Blackwood placed a restriction on withdrawals for both individuals and institutional investors. Starwood Capital Group has also told investors that withdrawals would be restricted.
The commercial property market works on very thin margins, which means it is extremely sensitive to interest rate fluctuations. The Federal Reserve funds rate currently stands at 4.5%. It was 0.08% in January 2022. Investors are also worried about the highest inflation rate in 40 years and the trend toward working from home. Inflation is particularly worrying for investors because the Federal Reserve has vowed to keep raising interest rates until the inflation rate returns to acceptable levels.
Zombie office buildings
This economic uncertainty is affecting tenants as well as investors. In major commercial real estate markets like New York and California, expiring leases and a lack of new tenants has left many office buildings virtually empty. These “zombie” buildings do not generate enough income to pay for renovations or improvements. Which makes them even less appealing to prospective tenants. Repurposing vacant commercial properties for other uses is one option landlords are considering, but this is rarely simple and often involves costly land use litigation.
Fear, uncertainty and doubt
The economy is a reflection of investor and consumer confidence, and it is unlikely to improve significantly until inflation is brought under control. This is bad news for the commercial property market as it means interest rates will likely continue to rise, which means the number of zombie buildings will likely continue to grow.