June 13, 2017
Economists overwhelmingly predict a short-term interest rate hike coming this week following the Federal Reserve’s two-day board meeting on Tuesday and Wednesday.
Should the Fed proceed as projected and bump its benchmark rate by a quarter point to a range of 1% to 1.25%, it will mark the fourth move made since December 2015. Bisnow reached out to commercial real estate experts to take their pulse on the current economic environment and how a rate boost, coupled with the volatility plaguing Washington, will affect the industry. From compressed cap rates to reduced deal flow, this is what industry experts had to say.
“When we look at the recent rate hikes, the Fed waited a year after December 2015 to raise rates last December, but that really wasn’t about our economy — it was due to a range of geopolitical issues. From the Chinese stock sell-off in the beginning of the year, which drove the S&P down precipitously, to Brexit to the raucous U.S. elections, 2016 was a tumultuous year headlined by non-economic issues; the result was that the Fed chose to keep rates low, despite strong economic performance.
“With unemployment at 4.3%, its lowest level in 16 years, and the economy performing well across the board, there’s every reason to believe that the economy is prepared for another rate hike.
“Following the most recent rate hikes, we’ve seen cap rates stay tight, as high liquidity and strong foreign investment activity have counteracted the interest rate rise. The Fed hiking rates further is really a signal that the economy is in a period of growth. While borrowing costs will clearly rise, the strong economy may also give investors the ability to achieve higher rents (in all asset classes). Because of this, we don’t expect to see significant moves in terms of either valuations or cap rates.”
Jillian Mariutti, Mission Capital Advisors debt and equity broker
“When we look at the recent rate hikes, the Fed waited a year after December 2015 to raise rates last December, but that really wasn’t about our economy — it was due to a range of geopolitical issues. From the Chinese stock sell-off in the beginning of the year, which drove the S&P down precipitously, to Brexit to the raucous U.S. elections, 2016 was a tumultuous year headlined by non-economic issues; the result was that the Fed chose to keep rates low, despite strong economic performance.
“With unemployment at 4.3%, its lowest level in 16 years, and the economy performing well across the board, there’s every reason to believe that the economy is prepared for another rate hike.
“Following the most recent rate hikes, we’ve seen cap rates stay tight, as high liquidity and strong foreign investment activity have counteracted the interest rate rise. The Fed hiking rates further is really a signal that the economy is in a period of growth. While borrowing costs will clearly rise, the strong economy may also give investors the ability to achieve higher rents (in all asset classes). Because of this, we don’t expect to see significant moves in terms of either valuations or cap rates.”
Chris Muoio, Ten-X quantitative strategist
“The commercial real estate market has seen deal volume drop in recent quarters as rising interest rates have increased financing costs and caused a divergence in pricing expectations among buyers and sellers. This was particularly affected by the spike in rates seen towards the end of 2016. The sudden nature of the shift in rates caused some deals that were agreed upon to be scuttled or renegotiated. Pricing has remained steady near cycle highs as cap rate spreads compressed to offset the rise in rates for the most part, but growth has plateaued, as the tailwind from interest rates has dissipated and the growth in fundamentals has cooled in many sectors.
“We believe the economy is prepared for at least one more hike this year, and possibly two … A rate hike in June feels fully baked into interest rate markets, and we would imagine most commercial real estate investors are prepared for this eventuality. Cap rate spreads would likely compress slightly to offset the modest rise, and we wouldn’t imagine a substantive effect on volumes due to the visibility around the move.
“With the tailwind of falling rates disappearing, fundamentals will become more important to pricing. This makes the hotel and retail sectors most vulnerable, as they have struggled to generate [net operating income]. Apartment is also potentially vulnerable as it has the tightest cap rate spreads, begging the question of how much more compression is possible, but apartment fundamentals have been solid thus far.”
Chris Thornberg, Beacon Economics principal
“Actually rates have barely budged and they are already fading from the Trump bump. The 10-year is hovering barely above 2% currently. As such I would be hard-pressed to call this a rising interest rate environment.
“If they raise (which may not happen), the real question is how much of a spillover [will there be] into long-run rates. The primary issue is the yield curve. If they do keep tightening, it will put the squeeze mainly on banks and other lenders. Banks have already become shy of construction and commercial lending — both in terms of volumes and spread. Tighter credit will have some dampening effect on the industry — but it’s not the interest rate, rather credit availability.
“The sectors that will see the biggest hit from tighter credit are those already on the front lines: construction and multifamily.”
Rajeev Dhawan, Georgia State University/J. Mack Robinson College of Business director of economic forecasting
“This June rate hike has been telegraphed for a while, but the Fed is now becoming cautious about any more hikes this year as some of their recent speeches have broadly hinted.
“Rate hikes are almost always in response to the economy running above its potential growth, and the evidence of that has been very mixed in recent months. Throw in the D.C. politics and the picture gets muddy when you look ahead. Has that impacted deal-making in CRE? It certainly hasn’t helped.
“Remember, foreign investment in domestic real estate deals is the icing on the cake and at some coastal cities it may be the entire cake. That is the flip side of the trade deficits … we run with our major trade partners, such as Germany, China, Mexico and the EU as a whole. Any impediments to trade, promised during the campaign time, which are now being considered, will not be good for the real estate sector as a whole, especially in the coastal markets. These areas should brace themselves for the inevitable ‘trade skirmishes’ later this year.”
Raymond Torto, Harvard Graduate School Of Design lecturer
“REITs indices kept pace with the general market in the last six months [and were] even a bit better as the assumption [took hold] that a better economy will be good for real estate.
“The economy can handle a rate increase, [though it remains] unclear if turmoil in D.C. will undermine confidence and the economy. “There has been no impact to date on [property valuations] as prices have held during the first half of the year. Volume is down, reflecting a pause in buying.”