Commercial and industrial developers are taking a number of different tacks to cope with the recent run up in interest rates.
Some are choosing adjustable-rate mortgages instead of fixed-rate loans, hoping that inflationary pressures will soon ease. Others are utilizing complex financing techniques to lower their borrowing costs.
Still others are simply cutting back their plans to build new office buildings or industrial parks.
But even maneuvers such as those may not be enough to avoid a widespread construction slowdown if interest rates go much higher, development experts say.
Some builders have already delayed planned projects because of high vacancy rates in many Southland commercial and industrial markets, and further rate hikes could force them to indefinitely postpone their plans.
Not Going to Build
“If (prime) interest rates hit 12%, or certainly 12 1/2% or 13%, construction is going to grind to a stop,” said Winston Elton, principal of the Goodkin Real Estate Consulting Group in San Diego.
“A lot of projects that are on the drawing boards now would stay there,” he said, “and even some of the developers who are ready to break ground are going to have to put their plans on the shelf for a while.
“If these developers don’t have good financing for their projects lined up yet, then they’re not going to build--at least not this year,” Elton said.
Most loans for commercial and industrial projects are linked to the prime rate, the rate banks charge their most credit-worthy customers--typically, other mammoth lending institutions. Developers usually pay a rate that is one or two points above prime.
The prime rate has risen steadily from about 9% last summer to 11.5% today, meaning most developers are now paying 12 1/2% to 13 1/2% for their loans.
The recent rate increases and prospects for further hikes have had a dual effect at KMK Real Corp., a real estate investment company based in Marina del Rey.
A few months ago, the company rejected an 11 1/2% fixed-rate loan to buy a shopping center in Acton, and instead chose an adjustable-rate mortgage with an introductory 8 3/4% rate, figuring the 2 3/4-point savings would save them thousands of dollars in monthly interest payments.
“We might have taken a fixed-rate loan earlier, but fixed rates are just too high now,” said Steve Meepos, a KMK general partner.
However, the company is considering paying a $20,000 fee to guarantee $2 million in fixed-rate financing for future buyers at a housing tract it is building in Redlands, fearing that future rate increases may make the homes unaffordable.
Save $50,000 a Month
Over at Jaric Development Partners, a mid-sized commercial and industrial developer based in Los Angeles, executives are using an increasingly popular financing technique to mitigate interest-rate increases and lower their borrowing costs.
Company officials recently needed to borrow a total of about $60 million for three different projects.
They had two basic choices: Take the usual construction loan of about 1 1/2 over prime, or get a loan from a local bank that was linked to the London Interbank Offered Rate, a global version of the U.S. prime.
Jaric took the loan linked to LIBOR. Even after paying the lender’s markup on the loan, Jaric is borrowing at 11 3/4%--a better choice than the 12 1/4% rate it would have paid by choosing the prime-plus-1 1/2-point loan.
“We’re saving $50,000 a month in interest charges,” said Michael J. McGarrey, Jaric’s chief financial officer. “That’s a big deal to a company of any size. After a while, you’ve paid several salaries with your savings.”
‘Businesses Get Nervous’
Officials at Carson-based Watson Land Co. have taken a much simpler tack to combat rising rates: They have decided to build only about 500,000 square feet of office and industrial space this year, down from their usual 750,000 square feet.
“We sat down in the final quarter of last year and (accurately) predicted that rates would keep going up in the early part of 1989,” said Richard M. Cannon, Watson’s president.
“When interest rates go up, businesses get nervous and cut back on their expansion plans. That translates into lower demand for space in our office buildings and industrial parks.
“We didn’t want to get stuck with a bunch of space that we couldn’t lease, so we decided to cut back,” Cannon said.