Analysts: Fed’s ‘Messaging’ More Important Than Fed Funds Rate Increase
The Federal Reserve’s messaging about future interest rate increases may have a larger effect on commercial real estate than its decision to raise the federal funds rate by 0.25 percent, analysts say.
“The move had been so widely telegraphed–and anticipated–that raising the Fed Funds rate alone was not likely to have a significant impact,” said Mortgage Bankers Association Vice President of Commercial Real Estate Research Jamie Woodwell. “The real news was in the Fed’s expectations for more rate increases in 2017.”
Woodwell said for commercial real estate, “the increase represents the latest signal that the ultra-low rates of 2016 are likely not the long-term norm, and borrowers who have not locked in long-term, fixed-rate financing will want to be vigilant about how both short- and long-term rates move going forward.”
Ernie Katai, Executive Vice President and Head of Production with Berkadia, agreed that the rate hike is something that people have seen coming for a long time. “Once the dust settles after the holidays, people are going to settle into the quarter-percentage jump as the new normal,” he said. “When rates go up, the first thing commercial mortgage bankers need to do is get creative and work a little harder to recalibrate financing and returns. This is what we’ll need to focus on come January.”
Chris Muoio, Senior Quantitative Strategist with Ten-X Research, Irvine, Calif., said the bond market had already priced in the Fed’s tightening. The 10-year yield increased from 1.5 percent before the presidential election to just above 2.4 percent currently, he noted. “[But] while interest rates have increased, they remain low by historical standards,” Muoio said. “With the yield curve still fairly steep, lending markets and conditions will remain healthy going forward.”
Katai said if the lending pipeline remains strong, “I’m confident that not too far into the new year, we’ll see momentum building back up and the industry accepting increased rates as maintainable long-term. In the event that lending does see a bit of a drop during the first quarter, long-term, investors have shown no sign of cutting back on dollars in 2017.”
Jonathan Hakakha, Managing Director with Quantum Capital Partners, Los Angeles, said borrowers can still find competitive financing. “Since the election, the 10-year U.S. Treasury yield has increased more than 60 basis points, which has negatively impacted the commercial real estate mortgage markets,” he said. “But despite the recent increased cost to debt capital, the fundamentals are still strong thanks to better and stronger income and rent trends along with job growth. While some lenders have become more conservative on their lending practices, there are still competitive lenders in the marketplace lending aggressively.”
Muoio said the Fed continues to signal that it will be “cautious” with future rate hikes to avoid choking off the expansion. “Commercial real estate valuations, though, [now] face an uphill climb,” Muoio said. “Cap rates have been aided this cycle by the steady decline in interest rates across the globe, triggering a search for yield. While cap rate spreads in most sectors still measure above their historical averages, rising interest rates will at the very least be a headwind to valuation growth.”
This concern becomes more acute in the multifamily and hotel sectors, which have seeing decelerating net operating income and revenue per available room gains due to supply additions, Muoio noted.
But as the Fed “normalizes” interest rate policy, property valuations will become more closely linked to fundamentals and the rising tide that has lifted all boats since the recovery began will go away, Muoio said: “Commercial property investors should take note of the shifting winds and make sure their holdings don’t have any undue interest rate risk and that deal assumptions factor in the changed landscape.”
