Savills ran an opinion piece by Mark Harris, CEO of SPF Private Clients, at one time the private financing arm of Savills, although long split off. In it, Harris argued that changing circumstances can mean that a property buyer might feel the pressure to renegotiate price.
Harris addressed his remarks to a consumer set looking for residential property, but the foundation of what he wrote applies to commercial real estate as well.
"Understandably, some buyers may now be feeling less confident about the future and may be tempted to renegotiate the price previously agreed with the seller," he wrote. "However, it's important to be aware that it's not that straightforward. Your lender will need to be told about the renegotiated price and even if the amount you want to borrow remains the same, you will need a new mortgage offer."
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That is essentially the circumstance for many commercial real estate deals. Property values are falling as financing rates climb, because buyers can't pay the same amounts as they would have in the past. The deals can make no financial sense with debt service coverage ratios taking a hit, to say nothing of expectations of net operating income and the rates of return that investors putting in capital want to see.
So, renegotiation becomes an issue. Buyers push to have prices come down as many sellers look wistfully back six to nine months and think of what they could have sold for then. The buy-sell gap has grown. Some current owners can afford to wait and keep prices high. Others are in poor positions vis-à-vis their properties and must either refinance at rates that badly undercut the financial plan; add additional capital to the financing, which they may not be able to raise; walk away from the financing, losing everything and handing the property back to the bank; or sell.
In a successful price renegotiation, the price is likely to fall, particularly with a motivated seller. So far, so good. But now, as with what Harris wrote, the buyer has to go back to the lender and explain the change. That changes the loan-to-value ratio, and in today's climate, more leverage will unlikely be welcome. A new mortgage process could add more processing costs and result in a new valuation.
Now the tricky part. Your rate today was likely locked in a month or two ago. But the Federal Reserve has continued its process of raising the benchmark federal funds rate, meaning that the new rate will probably be significantly higher. Now you need to again reevaluate the business plan to see if it is still viable at the higher rate. And all that assumes that, under current conditions, the lender is still willing to extend a loan.
In today's market, renegotiation is potentially part of a sound strategy, but accompanying it should be scenario planning, taking into account how much rates have risen since the previous commitment.
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