SVN: Small Rate Increase Unlikely to Have Significant CRE Effect

The Federal Reserve will announce an interest rate decision next week. But whether it raises rates or holds the line will not likely have a significant commercial real estate effect, said SVN, Boston. 

In a special report, Commercial Real Estate, Interest Rates and the Federal Reserve, SVN noted that the unemployment rate has remained stable below 5 percent, average hiring exceeds 200,000 per month and inflation exceeded 2 percent in the second quarter. “It is widely believed that the Fed will resume raising its rate this September if economic conditions remain stable,” the report said. But it noted that the most recent jobs report that fell shy of the hypothetical 200,000 target to sustain growth, “[leading] some to believe the rate hike will be paused to November.”

The Fed’s current target rate is 0.25-0.50 percent.

If the Fed does raise rates next week, the increase will not likely exceed .25 percent, SVN said. “A quarter-point increase in and of itself is not likely to have any real significance to commercial real estate or other long-term assets; what will be impactful is the perceived stance of the Fed going forward with regard to the timing and magnitude of future rate increases.” 

SVN said if the Fed indicates that it will aggressively fight inflation, then long-term interest rates will rise, as could investment real estate cap rates. But SVN called the aggressive inflation-fighting outcome unlikely. “The more likely outcome is a slight raise or even deferment to the November meeting, with continued guarded measures to watch conditions unfold,” the report said. “With GDP growth averaging around 1 percent, it is hard to envision great fears about an ‘overheated’ economy. Thus, it is not logical to expect much to change in the near term for commercial real estate, whatever the Fed may decide.”

SVN noted that the Fed primarily seeks two things: full employment and low inflation. At 4.9 percent, the U.S. economy is theoretically at full employment, the report said. “But given the slow rate of wage growth, small gains in productivity and seemingly tenuous inconsistencies in hiring–May added only 24,000 new jobs–there is not a widely held view that the employment situation is healthy enough to sustain new economic shocks.” It also noted that the unemployment rate that includes discouraged, marginally attached and part-time workers who would prefer full-time employment stands at 9.7 percent, above its hypothetical 8 percent target. “Thus, the Fed has little motivation to ‘pump the brakes’ and risk moving away from full employment,” it said.

Inflation is much trickier to assess, SVN said: “Overall, prices do not appear to be rising in totality, but certain areas such as shelter, transportation services and medical care are all growing at rates above 3 percent. If energy prices were to move upward, overall inflation could spike well above 3 percent. Thus, the Fed is pressured to not wait too long.”

Commercial real estate has benefited from high rent growth and simultaneously low interest rates and capital costs for several years, and SVN said this dynamic “is not poised to reverse itself in the short- or even medium-term.”

In fact, because fixed-income securities are much more vulnerable to interest rate spikes, more investment capital could move to commercial real estate assets if the Fed does decide to raise rates, SVN noted. “In summation, real estate investors have little to worry about this round; but, it would be foolish to believe this low interest rate, high rent growth environment will last forever,” the report said.