August 2015

Why Does Residential Real Estate Have an Effect on Commercial Real Estate?

The Residential Real Estate and Commercial Real Estate industry are so different, yet they affect each other in various ways. The following is a brief explanation of the impact that Residential Real Estate has over Commercial Real Estate.

Interest Rates

The impact is felt in the Commercial Real Estate market when interest rates change in the housing market.  The residential market is the "fuel" for the commercial market when interest rates are lowered to stimulate buying or refinancing a home.  A few examples of the stimulus are as follows:

1. A need for more office space is required as a result of a busier mortgage market.

2. The industrial market increases with the demand for manufactured products as a result of new home sales and the refurbishment of existing homes.

3. The commercial and retail real estate market increases due to the demand of products needed for housing.

Supply and Demand

The demand for Residential Real Estate in Los Angeles County, Orange County and Riverside County has been out stripping supply. Obviously, prices are increasing and the housing market is on fire!  The residential business in the Western United States is relatively in good shape. Therefore, the commercial market is greatly stimulated by the demands of the residential market.

Dangers of HELOC (Home Equity Line of Credit)

Home equity lines of credit are second mortgages that have been placed on homes. They are almost exclusively interest only loans with no requirement to reduce the principal of the loan. These loans have no restriction on their use.  Historically, these loans were used for home improvements but lately they have paid for college tuition, medical costs and almost anything under the sun.

HELOC loans have a maturity date of 25 to 30 years but can be paid off sooner with very small closing costs. The danger in the loan is that the terms reset at the end of 10 to 15 years.  At the point of reset, the entire balance of the loan must be amortized over the maturity of the loan. For instance, a 25 year HELOC loan at 15 years from maturity turns into a fully amortized loan at a floating interest rate. This reset could easily double the mortgage payment and place stress upon the owner. The consequences of this loan could easily have a serious impact upon the residential market. HELOC loans are resetting now and will increase in volume dramatically over the next few years.  The loans that are now resetting will have a negative result on Residential Real Estate and impact the Commercial Real Estate market.

Foreign Investment in Residential Real Estate

Foreign investment in Residential Real Estate has had a substantial impact on Commercial Real Estate especially in areas; such as, Las Vegas, South Florida and Southern California.   A large proportion of these investors have come from China.  At this moment, China is devaluing their yuan and the China Stock Market has plunged more than 30% in a month.  China is seeking a safe harbor for the yuan and looking to the US securities and bonds; as a result, it should keep interest rates low for the U.S. due to the Chinese demand in investing. This investment in Residential Real Estate has been going on for a long period of time and assisted in pushing up values in real estate during the recession.

I suspect that the continuing requirement for Residential Real Estate investments should continue to increase the values of Commercial Real Estate.

Is there a bubble in the real estate market?

A senior real estate executive informed me once; “The top of the market only lasts 20 minutes.”  If this statement is true, then it is my opinion we are close to that point.  Housing demand will not be this high for much longer. Many safeguards have been implemented during the recession.  The banks with their regulations on lending and mortgage lenders with extremely tough qualifications for loans should make it a soft landing; therefore, it shouldn’t have much of an effect on Commercial Real Estate.

One important factor to consider is that during the recession there were no new properties constructed and it is only now that you see cranes in the sky. Therefore, a glut of commercial properties has been absorbed and new construction will only satisfy current demands. The Commercial Real Estate market should withstand the adjustment in supply and demand and continue to make it a good investment for the future.

“Lee Segal is a one-stop shop when it comes to commercial real estate expertise. He’s a likeable person with a great sense of humor. His broad base of knowledge in commercial real estate and ability to build rapport with people make him a prominent force within his field.”    
Carol Newman, Alleguez & Newman, LLP