Commercial Real Estate Investors Are Banking On A Fed Rate Hike — Just Not This Month
UPDATE, NOV. 1, 2:08 P.M. ET: Following a two-day meeting, the Federal Reserve has left short-term interest rates unchanged. Officials signaled a move in December is likely.
The U.S. Federal Reserve is expected to hold short-term interest rates steady Wednesday as markets await President Donald Trump’s pick for the next Fed chair, which he will announce Thursday. Many are predicting central bank governor Jerome Powell will receive the nomination.
Investors overwhelmingly expect a December move, which would mark the third interest rate hike this year.
Bisnow spoke with commercial real estate economists and researchers to discuss how future moves will impact property markets and how investors are factoring higher rates into their deals.
Do you foresee the Fed moving rates this month, or by the end of the year? Why or why not?
We do not anticipate the Fed raising rates this month, but do expect a 25-basis-point raise at their December meeting. The economy appears robust, with two consecutive quarters of above 3% GDP growth and a strong labor market. While inflation has been subdued, the path to normalizing monetary and interest policy is more important than adherence to the 2% inflation guideline.
How would this move impact the 10-year Treasury, if at all?
While the 10-year will react to the news, the effect will be larger at the shorter end of the curve, such as the two-year and below. Most likely, this will result in further flattening of the yield curve as the shorter end rises faster than the longer end. Though this picture may become muddled as the president is set to announce the next Fed chair sometime this week. [The nominee] may hold a different outlook on interest rate policy.
How are these gradual rate moves affecting CRE investment, lending, etc.?
The gradual rate raises have had minimal effect on the CRE lending market, which remains very healthy. CRE valuations have plateaued as the rate hikes began, and higher rates resulting in plateauing cap rates [have] certainly been one of the contributing factors. Slowing [net operating income] growth, though, has also played a pivotal role. Transaction volume has dropped sharply this year and is partly owing to the higher interest rates that followed the election last November and subsequent Fed tightening. However, there is also a pricing expectations gap that has developed between sellers and buyers as we have noted in a recent report, and this is another important factor behind the slowdown in CRE deals.
Do you foresee the Fed moving rates this month, or by the end of the year? Why or why not?
The Federal Reserve will be taking into account indications of the strength of the recovery in the economy. GDP is up to 3% last quarter compared to 2.3% from a year ago. ... Retail sales, a good indicator of consumer confidence, increased 1.6% over the summer, a great increase since early 2015. Other indicators showed similar patterns. The result of this will definitely be at least one rate increase and most likely two if the trends hold. For the most part, the Fed practice of rate roulette is now accelerating and will show increases more frequently.
How would this move impact the 10-year Treasury, if at all?
The 10-year will begin to move later. This [will] definitely have an impact, but it will take a long time for the initial increase in the Fed funds rate to affect it. I suspect a six-month lag is most likely.
How are these gradual rate moves affecting CRE investment, lending, etc.?
The expectation of rate increases is already baked into the underwriting and valuation assumptions of most transactions and portfolio reviews among the more sophisticated owners and investors. A gradual increase in interest rates will encourage a deceleration in cap rate compression, but not eliminate it. Investment and lending practices will ultimately align with the rate changes as long as alternative investments follow the same trend. That isn’t guaranteed. The volume of CRE transactions is now declining as owners can’t see a clear target to reinvest their proceeds. We are several years away from that changing.
Do you foresee the Fed moving rates this month, or by the end of the year? Why or why not?
I do not expect the Fed to raise rates this week. It is too soon since the last increase and the economic data is still being impacted by the hurricanes, so they don’t have a really clear picture of the state of the economy. December is a different story. By then we will know a lot more about jobs and wages. If those numbers indicate healthy growth when we combine it with two strong quarters of GDP growth, there is good reason to expect another rate increase at that meeting unless employment growth falters.
How are these gradual rate moves affecting CRE investment, lending, etc.?
Most investors anticipate higher interest rates at some point in the future, during their hold period. So it is unlikely that a continuation of the current gradual rate increase program will have a significant impact on investment activity or pricing. Cap rates are still well above long-term Treasury rates, so there is something of a cushion there. Investors tend to get nervous when there are sharp moves in rates one way or the other. Those usually signal some shift in underlying conditions that may call for a re-evaluation of pricing. As long as the changes in interest rates remain gradual, it is unlikely that investor behavior will change significantly.
Do you foresee the Fed moving rates this month, or by the end of this year? Why or why not?
I think you can expect the Fed to tick rates up on us a bit. We’ve seen a nice surge in the overall economy, and I think they’ve shown a lot of caution for the last few years in keeping the rates relatively low.
How are these gradual rate moves affecting CRE investment, lending, etc.?
We live in a global economy and the major U.S. markets are still a great place to invest capital in assets that will prove to be secure for the long haul. Foreign investors aren’t particularly driven by relatively minor raises in market rates. They want access to gateway cities and good project fundamentals. Ultimately, [return on investment] is what is most important. We’ve also seen the market open itself up to a ton of alternative lenders with high liquidity and slightly higher cost of capital. The economy has proven it can handle a rate increase, though I will say that continued strain on our political system, and a deterioration of international diplomacy could undermine some of that confidence.
Do you foresee the Fed moving rates this month, or by the end of this year?
We do expect rates to increase, but the amount of the increase will likely be minimal. In addition to domestic job growth, we are starting to see global economic vibrancy in places like Portugal, Italy, Spain, Argentina and most importantly, China. This week’s U.S. GDP growth figure of 3% is definitely a positive development.
How would this move impact the 10-year Treasury, if at all?
The 10-year Treasury has moved up recently and will continue to climb as growth and inflation expectations increase. This should be viewed as a positive, as remaining in an abnormally low interest rate environment for an extended period of time is unhealthy and a sign of a weak economy.
How are these gradual rate moves affecting CRE investment, lending, etc.?
The direct impact of rising rates is to dampen CRE investment and lending volume because they are inversely correlated. However, the rate hike is itself an indicator that the Fed is confident in the growth of the economy, so there’s reason to believe that investment activity and lending will not be affected too dramatically.
Do you foresee the Fed moving rates this month, or by the end of this year?
In the words of Monty Python: “Can do. But won’t.” That is, the economy is strong enough to sustain another rate hike, and several more in the near future, but there’s almost zero chance the Fed will move this month, if only because they’ve been signaling that they’ll hike in December, and then two to three times next year.
The impact on direct CRE investment and lending will be vanishingly small, though REITs tend to take a hit. We are nearing the end of this property cycle, and there seems little doubt that overall property markets have already peaked, absent an unusually strong (and unexpected) stimulus out of Washington. But Fed hikes alone will not be the factor that kills the property cycle.
