Bankers Dismiss Concerns Over Rising Federal Interest Rates

While the specifics are not fully finalized, it is accepted wisdom that the Federal Reserve will be raising both the short-term and 10-year interest rates soon.

In a vacuum, such changes could be cause for concern that lending could be more difficult, especially for banks that have been increasingly challenged by private capital in the debt marketplace.

But the hikes are ending an extremely long period of low rates and have been well-telegraphed so that markets have been planning around them for months, Ackman-Ziff Managing Director Dave Jacobs and WSFS Bank Chairman, President and CEO Mark Turner told Bisnow.

“I don’t think it will have much of an impact," Turner said. "On one end, you’d think rising interest rates would cause cap rates to rise and dampen the interest in investments, but on the other hand, it’s a signal that the economy is doing well. So functionally, the way the Fed is planning the rises to be measured over the next couple of years, I don’t think it will have a significant impact on the real estate market.”

Turner, Jacobs and more financial heavy hitters will convene for Bisnow's Philadelphia Finance Summit event on June 20 at Philadelphia Suburban Development Corp.'s Pinnacle Business Center in Lansdale, a new, Class-A office building with 344K SF in the Montgomery County submarket.

While the lenders aren't concerned, PSDC CEO Mark Nicoletti expressed misgivings about the rate hikes' timing, speaking as a developer and borrower.

“Cost of capital is going up, and there’s already compression on margins," Nicoletti said. “If [the Finance Summit] was a cocktail party and not a breakfast, everybody would be drinking more than usual because the banks would be celebrating and the real estate people would be drinking because they’re worried about what the future looks like.”

If capital is getting more expensive, then two changes to the country's fiscal policy could be mitigating factors: the GOP tax bill passed early this year and the more recent rollback of Dodd-Frank regulations on most banks.

“The changes in tax rates in the near term should boost the economy, which should just add more certainty and stability to the likelihood of the path of [interest rate] increase that the Fed has outlined,” Turner said. 

A mere six months out from the changes in the tax law, Turner, Jacobs and Nicoletti said it is still too early to see the full effect they will have on the economy. With the Dodd-Frank changes, one only needs to look back to the period before the recession for a precedent to relaxed lending regulations. But there remain crucial differences between now and then, Jacobs said.

"Real estate values in certain sectors are already beyond the levels they were at in the peak before the crash, but the difference between then and now is that the underlying real estate fundamentals are better now than they were back then," Jacobs said. "Back in 2006-07, some lenders were underwriting pro forma assumptions as automatically going to happen, and for that reason alone there was so much more risk ... It was just [based on] faulty assumptions.”

Turner and Nicoletti agree that banks' lending behavior is unlikely to change significantly, with the latter predicting that the lower compliance costs required "will just improve banks' margins."

Generally, fewer regulations means fewer restrictions on growth and risk, which Philadelphia has always seen in muted fashion when compared with cities like New York, Boston, Washington, D.C., and San Francisco. That should mean that the city is relatively insulated against the worst-case scenario of the combined changes, Jacobs said.

Although Philly's job growth still lags behind the aforementioned cities, its strength in the stable education and healthcare industries could add to the city's advantage should the current fiscal policy backfire.

"There will be a flight to quality locations, and University City might compete nationally as a core market that might be immune to any weakening in the cycle," Nicoletti said. "There aren’t too many places in the country you could say that about. So we actually might benefit in some parts of the city from a national weakening in real estate.”

Nicoletti, Turner and Jacobs all said with ironclad certainty that Philadelphia has gained ground as a target for investment relative to other American cities in the past few years.

“I’ll get tear sheets from debt funds that list the markets they’re looking to invest in," Jacobs said. "And while not all of them include Philadelphia, it’s popping up more and more when it never used to. Institutional groups, both debt and equity, are paying attention more than they ever have.”

Come discuss interest rates, cap rates, debt, equity and everything you need to know about real estate finance at Bisnow's Philadelphia Finance Summit June 20.