Commercial Real Estate
The New Normal
The Federal Reserve raised the short term interest rate to a target range of 2.00 to 2.25 percent. Learn what this implies about the state of the economy and what commercial real estate investors should be thinking about today.
The era of transparency continues. The Federal Open Market Committee’s latest action—raising the Federal funds rate to a target range of 2.00 to 2.25 percent at its September meeting—is consistent with the Federal Reserve’s mandates to keep unemployment low and target a long-term inflation rate of 2 percent. The market implies an approximately 70 percent chance that the Fed will raise rates again in December. Learn how this impacts our commercial real estate community today and into the future.
- Rising rates are commonly received with trepidation by the real estate community, and with good reason—investors fear a pass-through effect of rising cap rates. However, it’s important to keep in mind that the economy is growing. US workers are finally experiencing wage growth, which can lead to improved commercial real estate fundamentals. Today’s rising rates can actually serve as a stamp of confidence for the US economic outlook.
- Most economists are predicting two to four more rate hikes in 2019, in line with the expectation that the Fed will continue to raise rates with modest bumps of 25 bps as the economy hums along. In their latest economic projections, the Fed hints at three 25 bp rate hikes during 2019. No one likes surprises, so next year’s rate hikes are something for businesses to stay aware of.
- The non-zero rate environment of today is beneficial to real estate, as the Fed once again has the ability to lower rates as may be needed in the future to offset any possible downturn. Many investors certainly benefitted as they sought yield in real estate during the unprecedented zero rate environment. However, it’s important to remember the fundamentals of US real estate’s dependence on the domestic economy. Fundamentals drive real estate and rates.
- Moving forward, another area that will garner more attention is the continued and increasingly flat nature of the yield curve. This supports the belief that the Fed will maintain its intent to raise rates gradually and slowly. Although the spread is narrow (25bp difference between two and 10 year treasury yields), there is no current indication that it will go negative (which in the past has often signaled the onset of a recession).
- It’s important to maintain discipline in light of rising rates. Over the next few years, rates will likely continue rising. Investors should carefully consider the metrics of each deal as though rates could move considerably both during the loan term and at exit.
Currently, the unemployment rate sits at 3.9 percent, the core personal consumption expenditures price index (key inflation indicator) is up 2 percent year over year, and this week the Fed dropped the phrase that “the stance of monetary policy remains accommodative” — all signs that the Fed is currently meeting its target mandates. Still, it’s important to remember the position of the US as a leader in the global economy. There are several factors in addition to rates that could impact the commercial real estate industry, such as tariffs affecting input costs or employment based on the competitiveness of US goods and services abroad. With such dynamics, opportunities may arise that not everyone can capitalize on. It’s important that investors remain positioned in their balance sheets to make the most of opportunities, irrespective of the market cycle.