Will Higher Interest Rates Blindside CRE? Probably Not.

"The persistent pattern of low cap rates for many real estate assets is an important factor in how higher rates will affect commercial real estate," according to The National Association of Realtors chief economist.

cre imageWednesday is day two of the latest Federal Open Market Committee’s latest meeting, and the betting money still favors a small rise in the Fed’s overnight rate, the first in more than six years. Less certain is a series of raises throughout 2016, though if the economy continues to be reasonable strong, that’s a distinct possibility. The National Association of Realtors chief economist Lawrence Yun told MHN that the recent, persistent pattern of low cap rates for many real estate assets is an important factor in how higher rates will affect commercial real estate.

“Cap rates have been exceptionally low in many places, and with rising interest rates, that means that rents will have to be much higher, or valuations lower,” he said. “Some of the choicest properties in markets like San Francisco or New York, whose cap rates are very low, are thus exposed declines in valuation,” especially if rates continue to go up, since rents can’t be pushed much higher too fast. But the decline won’t be drastic, Yun added, since market fundamentals are still strong. “As long as jobs are created and occupancies rise, valuations will be relatively strong,” he said. “Also, Class B and other secondary markets won’t be affected very much by rising rates.”

On the residential side, Stifel Fixed Income chief economist Lindsey Piegza told MHN that the initial rate increase—presumably 25 basis points—is unlikely to affect mortgage activity markedly in the short term. “After all, a 25-basis point hike is unlikely to translate into more than a few basis points increase, if any movement, on the longer end of the curve from which mortgage rates are derived,” she said.

The more important implications come from the longer-term pathway of rates. “If the Fed is determined to raise rates further beyond liftoff, without meaningful improvement in the consumer sector, higher rates will translate into higher mortgage rates—which will mean an increased inability of consumers to afford their monthly mortgage payment,” Piegza said. “An additional $50 to $100 is a meaningful increase for struggling homeowners.” In short, higher rates could eventually mean that consumers would suffer an increasing inability to finance large purchases (and that’s something for car dealers, who have done so well lately, to think about).