Dealing with the new reality in commercial real estate
Higher interest rates and inflation have created a new reality for business owners who are trying to choose the best real estate option for their company.
The rapid increase in rates has made financing more expensive, while inflation and labour shortages have boosted the cost of construction and renovation projects.
For renters, the renewal of a lease can mean a punishing increase, especially in major centres where there continues to be a shortage of commercial spaces to rent or buy.
We finance many real estate projects every year. Here is what we’re advising for entrepreneurs navigating today’s volatile market.
Create a plan based on different scenarios
With so much economic uncertainty, it’s imperative to have a clear strategic plan for your business before your start looking for a property. It should include conservative financial projections covering different interest rate and growth scenarios.
Armed with this plan, and with your advisors, you can start asking key questions that need answers before you can make a real estate decision :
- How much space can you afford?
- Would you do better by moving to another part of town?
- Will your cash flow be squeezed if rates go up or the economy is hit by a recession?
- Will you have enough room to grow?
Bring your banker in early
If you’re planning a real estate investment, it’s always a good policy to talk to your banker early in the process. They can give you an honest opinion on what you can afford based on your cash flow and existing debt level. They may even be able to pre-approve you for an amount that will allow you to move quickly on a transaction in a tight market.
Besides these advantages, we encourage our clients to talk to us early because we may be able to help them find the right property for their needs. We’re involved in many transactions and talk to lots of brokers, accountants, lawyers and entrepreneurs. We may hear of a property that fits your specifications and help you land a deal.
Ensure you borrow enough money to cover contingencies
Even if you’ve put away money for a sizeable down payment, you’re often better to finance a higher percentage of your real estate investment to ensure you’re covered for unforeseen expenses.
For example, when you purchase an existing building, the cost of moving and getting your business up and running in the new location may be higher than you expected. For new construction, cost overruns and delays are common.
You want to make sure you have borrowed enough money so you don’t have to expend your precious day-to-day working capital or go back to the bank to negotiate a further injection of funds under duress.
Fixed or variable? Focus on risk, not interest rate forecasts
It’s tempting to base your decision on whether to take a fixed or variable interest rate based on a forecast of where rates are headed.
However, rather than trying to guess where interest rates will go, it’s better to think about risk when choosing between a fixed and variable rate. If you choose to go variable and rates go up by two or three percentage points will your business be in financial difficulty? Are you going to be constantly worrying about rates?
A variable rate may be the right choice if you have the financial flexibility and the risk tolerance to support that decision. However, many entrepreneurs we work with prefer to have the peace of mind and planning certainty that come with a fixed rate and predictable monthly payments.
Boost your operational efficiency and technology use
Our clients have reaped huge benefits by increasing their operational efficiency and cutting waste. The gains often include a more agile workforce, reduced floor space needs and better inventory management that may mean you can purchase or rent a smaller space.
As well, the trend to remote work is not going away. Many companies are finding they can get by with a smaller location or convert office space for other uses, such as warehousing or operations.
Try negotiating a lower rent increase
Rents have gone up sharply in the markets we serve. The reality is that landlords continue to have the upper hand because the supply of commercial space remains constrained and the economy continues to be resilient.
Nevertheless, it’s always a good policy to try to negotiate a lower rent increase with your landlord. While you may be focused on the difficulties involved in moving to a new location, your landlord may not want to go through the hassle of finding another good tenant.
Your landlord will also be aware that the economy is slowing and may prefer to lock you into a lease even if it means agreeing to a lower rent than taking a chance on finding someone new.
Take a long-term view
We remind entrepreneurs who are hesitating about buying a property because of rising interest rates to keep their eye on the long term.
Purchasing real estate has been an excellent investment historically. It allows you to build equity while watching the value of your property grow.
It’s also an asset that can be used as collateral for financing growth projects and it can provide you with retirement income even after you’ve sold or wound down your operating company.
The bottom line is you need to evaluate your needs now and in the future, taking into consideration such factors as automation and the trend toward remote work. Will you need more or less space? Where is the best location for your business? It’s not easy work, but planning now will be pay dividends when you’re making decisions.
Find out more about commercial real estate
Learn how to locate the right property, get financing and negotiate the best purchase price in our free guide for entrepreneurs: Buying Commercial Real Estate.