Interest Rate Hikes Reflect Expected Strengthening of Economic, Employment Conditions
By: Mark Heschmeyer
Date Posted: December 16, 2015
After seven years of worrying over raising interest rates, discussing the best time to raise interest rates, and debating the impact of raising interest rates, money from the federal government is no longer free.
In a unanimous vote, the board of the Federal Reserve voted to raise interest rates a quarter of a percentage point.
The hike has been anticipated for nearly six months, thanks to a thorough communication strategy from the Fed that all but eliminated the element of surprise for a jittery stock market. The increase became a foregone conclusion following strong employment growth numbers last month.
Additional interest rate hikes are expected going forward, but will come slowly as the Fed continues to take an accommodative stance supporting further improvement in labor market conditions and a return to 2% inflation.
The impact from the decision could also take some time to surface.
“We do not believe today’s move will have any impact on the commercial real estate markets and that the Fed likely has significantly more room to move before we begin to see real pressure on cap rates,” said Spencer Levy, head of research, the Americas for CBRE. “That said, certain markets may be more susceptible than others to interest rate increases.”
The other wild cards Levy said could have a bigger impact than interest rates include the price of oil, an economic crash or ‘hard landing’ in China, which would lead to pull back in Chinese capital flows, or some other “black swan” event which would impair global growth.
Any such event could easily cause the Fed to reverse course, neutralizing any potential capital outflows, Levy said.
“The flow of international funds-combined with domestic pension funds’ large pools of capital allocated to commercial real estate but unspent-will outweigh any potential increase in the cost of capital,” he added.
Hans Nordby, managing director of CoStar Portfolio Strategy in Boston, agreed that today’s Fed rate hike should have little or no impact in the near term for private sector commercial real estate investors.
“First, while nominal cap rates are very low versus history, the spread between going-in cap rates and comparable investment vehicles, including bonds, stocks and treasuries, is very high,” said Nordby. “Therefore, rates can come up a bit before cap rates need to rise.
“Second, the Fed chose to increase rates because the ‘real’ economy, most notably job growth, is strong. Strong economies increase demand for real estate, and therefore rents. So, these increased rates are in tandem with higher incomes for the real estate, all else being equal,” he added.
“Finally, the fed is unlikely to push rates very hard in near future, given that growth outside the U.S. is very low, and the dollar is very high. Pushing up rates would make American exports even less competitive, just as foreign markets’ demand for U.S. goods is declining.”
Jeffrey Rinkov, CEO of Lee & Associates, said he also expects the rate hike will have minimal impact on commercial real estate.
“Based on a strengthening and stabilizing economy, I believe this was a logical move by the Fed,” Rinkov said. “While the Fed is driven by data, I think this signifies its belief that the economy can operate in an environment with a normalizing monitory policy. Relevant to real estate investment, long term interest rates should remain at historical low levels which will continue to incentivize investment.”
Housing Could See a Boost
One area that could see relief from a higher-rate environment is housing.
Steve A. Schwarzman, chairman and CEO of The Blackstone Group, took an informal show of hands survey last week at Goldman Sachs U.S. Financial Services Brokers Conference, asking the audience how many thought rising interest rates would hurt housing prices and then how many thought it would help.
Hardly anybody raised their hands when asked whether housing prices go down. And about a third of the room put up their hands very slowly when asked whether housing prices go up.
“Well,25 over the last 26 times in history when interest rates went up the value of houses went up,” Schwarzman said. “Because when you have inflation or you have people making more money with the economy growing, that tends to push up the value of houses.”
The more interesting question about interest rates, Schwarzman said is how slowly prices go up.
“But if the markets want to be down on real estate values, that’s okay,” Schwarzman said, “because then we’ll just take out some huge companies, put out huge amount of money at very good prices and what happens at the underlying assets are always worth way more than the stock market is willing to value at the stage and a cycle.”
Martha Peyton, managing director of TIAA-CREF Global Real Estate Strategy & Research, acknowledged that there are fears rooted in the perception that rising interest rates will weaken property values and commercial real estate (CRE) investment performance.
“But, historical data show that higher interest rates have not necessarily derailed CRE total returns, Peyton said. “In fact, property performance has often remained resilient in the face of rising rates. Furthermore, there are a number of factors that may provide protection to overall property performance in a rising interest rate environment.”
The most important protective factor, she said is that rate hikes in the current environment reflect expected strengthening of economic and employment conditions.
Link to Article: Fed Raises Interest Rate