Proposition 10: A Threat to All Property Owners and Investors
Interest Rates on the Rise: Key Considerations for Your CRE Investment Strategy
While interest rates remain historically low, over the last several weeks we have seen rates on the rise. JPMorgan Chase is leading the way, announcing it has increased rates by another 0.5% moving rates in just two weeks from 3.25%-3.75% to 4.25% and up.
2013 has brought changes to the market that have many commercial real estate investors nervous. Many are asking, When is the right time to sell? Should I hold onto my assets or exchange? And if I do sell, how can I ensure I’m getting the best possible price?
With brokers telling clients to buy and sell, it’s hard to know what is the right choice for your investment portfolio. To help cut through the clutter, we want to share some insights from Marcus & Millichap Capital Corp’s Managing Director Bill Hughes. Here is a Q&A with Bill on the recent developments in the U.S. financial markets.
Q: What caused the recent volatility in interest rates?
A: In an effort to be transparent, the Fed has suggested that the central bank could begin to scale back its aggressive bond-buying program later this year but this communication may have been misinterpreted by the markets. This has caused a sell-off in the bond market, pushing the 10-Year Treasury yield from 1.66 in early May to 2.6 percent on June 25th. As a result, mortgage rates have jumped considerably. The situation has actually been exacerbated by widening spreads brought on by this sudden market volatility. In this instance, increasing interest rates are not related to perceived real estate or inflation risk.
Q: What is Marcus & Millichap’s perspective on the recent move?
A: Marcus & Millichap has anticipated a transition period from stimulus-driven economic growth to fundamentals-driven economic growth at some point; however, based on the latest jobs and inflation data, the economy is not overheating by any measure. When much stronger job growth takes hold and core inflation accelerates, interest rates should rise accordingly. Most economists do not expect this to occur for at least another 12 months, at which point the strengthened economy would produce higher demand for commercial real estate. In turn, higher demand for space would result in higher occupancies and rents, creating a relatively balanced movement in the markets. However, given the magnitude of the Fed’s accommodative stance and extremely low interest rates over the past 12 months, it is not surprising to see a period of over reaction to the simple notion that the Fed will eventually ease up on the accelerator, let alone tap the breaks.
Q. Which property types/price ranges are most impacted?
A. Properties impacted most are those trading at very tight margins, producing extremely low capitalization rates. Specifically, investment-grade STNL assets are the first to be impacted, but other institutional grade, class “A” assets generally trading at very low capitalization rates are also being affected. In addition, properties with revenue streams dictated by longer term leases would generally be impacted more by rising rates than those with near term upside.
Q. What are the key considerations for investors?
A. We have consistently highlighted the unique opportunity to lock in extremely low interest rates ahead of an improving economy and rising Net Operating Income (NOI). The last two weeks have illustrated the importance of moving off the sidelines and executing a strategy quickly. Whether the strategy calls for a refinancing, selling a particular asset or buying/exchanging into the right asset(s), the current interest rate environment and property cycle provide an advantageous window for investors. Many of our capital sources are holding rates to accommodate timely closings as well as to build their market presence. Numerous options and sources for every situation remain available and we can help clients evaluate each case and option.
Q. What are the best strategies for investors in this climate?
A. Rate increases caused by this sudden market turmoil have already impacted the market. Agency lenders, life insurance companies and CMBS issuers have all increased rates dramatically over the last couple of weeks. Commercial banks have started to move as well, taking advantage of better margins. At this point, it is more important than ever to have a good, active debt/equity intermediary that can help lead clients through these volatile times. There are lenders that are underwriting and pricing aggressively for the right transaction.
Q. What should we anticipate going forward?
A. Various Federal Reserve representatives have been working to ease fears that the Fed will pull back on the $85 billion per month bond buying program or raise the Federal Funds rate, reiterating that they have targeted 6.5 percent unemployment. While “tapering” remains in the cards, the Fed is quite mindful of the importance of supporting the economic recovery. Therefore, we anticipate rates to settle, if not even come in a bit as concerns ease. Structurally, it is important for investors to realize that interest rates have to move up as the economy performs better over the next year to two years. However, a significant inflation run is not expected and therefore, even “normalized” interest rates should remain below historical averages in the foreseeable future.
For more information or to speak with an Azzi advisor, call 310.909.5442.
