Interest Rate Volatility Continues to Challenge Markets
Early in my career I attempted to predict interest rate movements in our newsletter. I quickly learned to stay in my lane. In fact, I often tell my clients that if they think they can predict interest rates, they should be trading bonds instead of buying real estate.
Economists are predicting two 25 basis points cuts in November and December followed by 100 basis point cuts in total in 2025.
Before the Fed cut interest rates on September 18, the average 30-year residential mortgage rate in the US was at 6.11%. Today it’s at 7.09%. Up 98 basis points in under 2 months.
While 2019 saw a significant spike due to the implementation of the graduated excise tax, and 2022’s numbers were inflated by the Donahue Schriber Portfolio sale ($525 million for 9 Washington State properties), the reality is that we’ve been hovering at or below $1 billion in annual volume for the past three years.
While overall cap rates have remained relatively stable (with only a 55 basis point spread between average highs and lows), individual property types tell a different story. The drugstore sector, in particular, is experiencing significant disruption.
This chart shows the average cap rates for drug stores in the Pacific Northwest.
Walgreens recently announced it will close 1,200 stores over the next three years, beginning with 500 locations in 2025. This move represents a nearly 14% reduction in Walgreens’ total footprint of 8,700 stores and is part of a larger trend in the struggling pharmacy and drugstore industry.
Rite Aid recently exited bankruptcy as a private company, the closed around 700 stores 36 of which were in Washington.
One of the most striking trends is King County’s negative net retail deliveries in 7 of the past 10 years. The market hasn’t seen positive net absorption since 2019, contrasting sharply with national trends showing positive deliveries throughout the decade. Over the past five years, King County’s inventory has decreased by 1.4 million SF – a reduction matched only by Orange County among major markets
The overall U.S. CMBS delinquency rate has risen to 5.70%, with retail traditionally tracking slightly higher. What’s particularly noteworthy is the recent spike in drugstore delinquencies, which historically remained below 1%.
Perhaps no single property better illustrates the current market challenges than Pacific Place in Seattle. After Madison Marquette’s total investment of $412 million ($278M for the building, $87M for the parking garage, and $54M in remodeling), the property recently sold to BH Properties for just $88.25 million – roughly equivalent to what Madison Marquette paid for just the parking garage in 2016.