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Soaring interest rates. Volatile markets. Economic uncertainty. Investors have been hit on all fronts lately.
While the Federal Reserve indicated in May that it might pause its streak of rate hikes, there’s still plenty of work to do to tame inflation. Here are a few things to keep in mind about interest rates.
As always, it’s important to differentiate between short- and long-term interest rates and how the Fed’s actions impact each.
Forecasting these rates can be particularly difficult because the Fed and market frequently aren’t aligned.
“There's been basic tension between what the Fed says and what the market believes for some time,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at JPMorgan Chase.
“The Fed has made it clear: Their No. 1 job is to contain inflation, and their intent is to keep the short-term rate high for as long as it takes to do so,” he said. “The Fed’s messaging indicates it could hold interest rates at the current level, or even higher, through 2023.”
“The market generally anticipates a pause for a meeting or two, although some look for a hop, skip or jump where the Fed raises interest rates at a subsequent meeting,” Kraft said.
While the odds of a recession are up in the air, the possibility looms large over commercial real estate.
“Higher borrowing costs combined with concerns of an economic slowdown have been headwinds to commercial real estate,” said Ginger Chambless, Head of Research for Commercial Banking at JPMorgan Chase. “However, underlying fundamentals vary greatly by segment.”
Demand for multifamily properties remains elevated due to the tight housing supply and high mortgage rates, which have made home purchases more expensive.
Typically, interest rates decrease in a recessionary environment. How quickly rates drop and to what degree depends on how high inflation is running and the severity of an economic slowdown.
Lower interest rates could benefit commercial real estate values in the long term. “But in the near term, values could be hurt by a pull back in business and consumer spending activity,” Chambless said.
Amid economic uncertainty, real estate investors may consider hedging options. Before you decide to hedge against interest rates, you should:
While interest rates have a unique influence on commercial real estate, it’s important to look at multiple economic factors, including:
It’s also important to consider factors specific to commercial real estate, such as location, asset class and cap rates, as well as demographic shifts and supply and demand.
An economic downturn could have a significant impact on commercial real estate. Find out how multifamily investors can prepare.
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