What you may ask is property obsolescence? It’s a hell of a lot more than a remodel. Understanding the concept may also go a long way to determining whether or not you make money on your next income property investment.
This is particularly true given the era of “financial repression” (Edward Chanellor, The Price of Time. The Real Story of Interest) we may now be entering.
Everyone has a balance sheet consisting of assets and liabilities. On the asset side, low interest rates inflate the value of the assets on your balance sheet. This applies to real estate, stocks and bonds. Hence, you feel richer.
On the liability side, you pay low interest rates and everything feels more affordable.
Rising interest rates reverse this process. As rates rise, asset prices historically have gone down because the cost of money reduces the size of the buyer pool. This makes you feel poorer.
On the liability side, paying higher interest rates, things seem less affordable.
The current round of Fed rate hikes has triggered a financial crisis wiping out trillions of dollars in value across global stocks and bond markets.
The losses endured by central banks backstopping these losses have been enormous.
In turn, this may usher in an era of financial repression where credit is much harder to get as governments inflate their way out of debt. This will have serious repercussions in CRE.
Financing will likely get tougher across the board. However, this maybe particularly true for newly distressed asset types.
Distressed asset climbed significantly in the second half of 2022. Around 65% of these newly distressed assets were in the retail and office sectors (ALM Global 3/23/2023).
However, unlike past ‘crunches’ these are not situations where otherwise cash-flowing properties simply had short term problems. The office and retail sectors are facing fundamental challenges tied to property obsolescence now.
This means changes in lifestyle and technology are making these property types increasingly obsolete. This obsolescence may be exacerbated by the increasingly restrictive lending environment coming in the wake of the free money mess.
Repurposing a building after it goes dark, is expensive. Banks may be unwilling to lend on properties that are already underwater.
This supports our original argument that in our current environment operating assets (self-storage, senior living, multi-family, etc.) may be best. All these are directly or indirectly associated with habitational needs. This is unlikely to be made obsolete by changing lifestyles and technology anytime soon.