Arkansas real estate is ripe for pickin’

For the last several years, I have been anticipating the current situation in commercial housing investments: a wave of mortgages approaching balloon-payment maturity after originating during the low interest-rate environment of 2020-2022.

Several national analysts estimate there is $3 trillion in commercial real estate debt either already due or coming due. Arkansas probably has a tiny fraction of that, but what matters more is what it means in practical terms for investors, tenants, homebuyers, lenders, and local economies. Commercial loans don’t always work similarly to the mortgage on a typical home.

Most homeowners understand the concept of a fixed 30-year or 15-year mortgage. You buy a house, lock in an interest rate, make payments over time, and gradually reduce the principal. Real estate taxes and insurance may fluctuate, but the payments on the note do not change. Commercial lending on real estate rental properties often (not always) operates differently.

A substantial number of commercial real estate loans are structured with long amortization schedules — perhaps 20 or 25 years — but with balloon payments due after only five years. In effect, the borrower makes payments as though the loan were in a 20-25 year term, while knowing a large principal balance will become due. Let’s look at a hypothetical:

John and Jane Doe buy a house and borrow $200,000 on a 30-year term, at a fixed rate of 4% when rates were low. If they remain in that note for 30 years, it will be paid off. If they sell or re-finance before then, the principal balance goes down monthly. After 5 years, the balance is $180,895, after 10 years $157,568 and so forth. The loan payment never changes.

If “ABC Investments” bought the same house, borrowed the same $200,000, and the bank offered them a loan with 20-year amortization at 4.95% (higher interest rates are common for investment versus owner occupancy) but a balloon payment after five years, in the 59th month, they have to plan to come up with $166,760. They have three options: pay the balance off entirely, refinance, or sell.

With respect to the first route, most investors prefer not to tie up large amounts of capital. As for the second option, refinancing today often means higher interest rates, higher monthly payments, closing costs, and a new loan application. This might also mean raising rent on tenants or suffer losses every month. The third option is to sell the property.

Ordinarily, that might not sound concerning. But if large numbers of owners attempt to sell simultaneously, markets can become saturated. Increased inventory without demand applies downward pressure on prices and extends market times. Neither of those is good.

Buyers might read this and think that this is good, i.e. prices on houses will come down. And that means it is a good time to buy. That is wrong. What if one buys, and then property values continue to go down?

No buyer wants property values in their area to go down. One should buy property in hopes that it goes up in value. Too many buyers think they will wait for interest rates to go down. The inverse is better. Buy when interest rates are high, and don’t buy when house prices are high. One can always re-finance later and make the payments go down. One can never change what price they paid for a property.

So why is real estate “ripe for pickin’” now? Central Arkansas has historically experienced more moderate property value swings than other areas of the country. The risk of a drop in property values here in years to come is low.

Interest rates are not what they were a few years ago, but they are not horrible. If they go up, you prevail. If they go down, when it is right to re-finance or move up to a bigger property, you win.

Take advantage of the higher inventory sooner rather than later. You will find something good, you will help our market from dipping any more than it should, and you will be even more ready for when better rates and better houses are in your view.

Editor’s note: Jerry Larkowski is an attorney and real estate broker with ESQ Realty Group in central Arkansas. The opinions expressed are those of the author.