After a year of strong economic performance, the Federal Open Market Committee (FOMC) voted at their year-end meeting to hike interest rates by 25 basis points. They also released projections which reveal that they intend to increase rates three more times in 2017. Although this most recent hike was long-anticipated and baked into market rates, some commercial real estate investors are concerned a higher rate environment will negatively affect them.
Fears that upcoming rate hikes will be detrimental to commercial real estate are unwarranted. People all too frequently focus on interest rates, but frankly, they’re artificial. Rates are important to watch, but it’s far more important to understand the health of the economy. A deeper look at the economic environment—and what’s driving the Fed to raise rates—are positives for commercial real estate investors and owners.
It’s important to keep in mind that the Fed has been incredibly cautious about normalizing rates: December’s rate hike was only the second time in the past decade that they moved to raise rates. When the Fed chooses to normalize rates, it’s because they’re confident that the economy can take it.
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The 30-Yr average for the 10-Yr Treasury is 5.21%
Source: The Federal Reserve
If you take into account the Fed’s caution to raise rates, and the underlying economic factors that inform their decision, investors should be comforted, not concerned. A stronger and growing economy will be a positive for investors—even if rates rise. When there’s job growth, higher wages and on-target inflation, investors will have steadier cash flow by commanding higher rents, as well as higher sale prices.
Rather than fear normalized interest rates, one big thing we’re discussing with our clients in many of the markets we serve, is the oversupply of high-end properties. Higher interest rates can actually help to temper the risk of oversupply by motivating borrowers to be more prudent with seeking financing on new construction.
Overall, investors need to stay informed, be strategic and think long term. You should create a balance sheet that can withstand increases in interest rates, and make sure you’re building a portfolio that can be successful throughout the cycle. You need to know what’s happening in the economy and what could impact interest rates—and most importantly, you need to be hyper-vigilant about the markets in which you invest, down to a neighborhood-by-neighborhood, street-by-street level.
We tell our clients that they should be thinking 200 to 300 bps higher. Which, a quick look at historical rates, will tell you is not much. If that’s going to make or break the deal, it’s likely not a smart investment.
Strategic and informed commercial real estate investors will do well in any rate environment. And never forget: The worst moment to have to sell is in a down market. You want to be in a position to purchase the properties that have too much leverage during a downturn, so you can benefit from the natural cycle of commercial real estate.
This article first appeared in the Commercial Observer.