Impact of the 5th increase in interest CRE – Commercial Property Executive
Wednesday’s news that the Federal Reserve Bank raised interest rates again is hardly surprising, as the central bank has yet to see inflation slow. Despite four previous rate hikes this year in March, May, June and July, consumer prices as well as consumer spending remain elevated.
The Fed raised the federal funds rate by 0.75% for the third consecutive time, bringing it to a range of 3 to 3.25%. The average 30-year mortgage rate has been raised to 6.25%, the highest we’ve seen since 2008.
Earlier, on March 16, the Fed announced a 25 basis point hike in response to economic pressures from COVID, inflation and the war in Ukraine. This is the first increase in more than three years. In May, a 50 basis point increase associated with the smallest gain in the jobs report since April 2021, with the addition of only 390,000. The largest increase since 1994 came in June, when the Fed increased its rates by 0.75 percentage points. The second 75 basis point increase followed the following month, with July pushing the fed funds rate into a range of 2.25 to 2.5%.
The new interest rate hike follows a recent report by the Bureau of Labor Statistics showing that the consumer price index for all urban consumers (CPI-U) rose 0.1% in August, a higher increase than expected. Although the CPI fell slightly from a year-over-year increase of 8.5% in July to 8.3% in August, the improvement was not enough to stop a further rise rates from central bankers.
Potential market trajectory
The Federal Reserve’s dot chart predicts the path for rates to rise to 4.6% in 2023 due to a potential 1.25 points of further increases throughout the year. As recently as March of this year, the federal funds rate was set near zero.
“The third straight 75 basis point hike and continued references to broad-based price pressures and future hikes ahead underscores how singularly focused the Fed is now on trying to control inflation,” Brian said. Coulton, chief economist at fitch reviews. “Based on our forecast that the Fed will raise rates to 4% by December, this will be one of the fastest episodes of Fed tightening in the postwar period.”
Fitch Ratings has lowered its growth forecast since the June Global Economic Outlook, now expecting global GDP growth of 2.4% in 2022. This is a drop of 0.5 points. percentage.
Carlos Legaspy, Chairman and CEO of Insight Securities, noted that he believes inflation has peaked and that the Fed will stage further hikes to see if inflation is indeed coming down. However, if not, he says he thinks we will see further increased rates. “For the markets, a 0.75% is already priced in, if it’s more than that it could shake the markets. If it’s 0.75% or 0.5%, it may give the market an excuse for a relief rally. Markets will continue to be choppy through the end of the year,” Legaspy said. commercial real estate director.
There are promising potentials for lower inflation. A investigation consumer expectations by the Federal Reserve showed that median one- and three-year inflation expectations fell from 6.2% and 3.2% in July to 5.7% and 2.8% in August.
“We expect to see inflation stabilizing, probably around current levels, before starting to moderate, perhaps quite quickly, next year,” said Nick Axford, senior economist and chief Avison Young, told CPE. “Nevertheless, we expect to see further rate hikes from the Fed during the fourth quarter, likely in smaller increments, until it is clear that demand in the economy has slowed and that the “demand pull” inflation that has been driving up prices is coming under control. This deliberate policy of slowing the economy will not trickle down to demand in the real estate market, while the increase in the risk-free rate (yield on 10-year government bonds) that we have seen will impact the prices of all investment asset classes, including real estate assets.
Impact on CRE funding
“One of the areas targeted by the Fed is real estate. It wants the cost of housing to stop rising, so there is a significant headwind in the sector. However, if the Fed fails, real estate offers a good protection against inflation. These are the two forces that clash,” said Legaspy.
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Real estate has seen an economic downturn in the construction of new homes while mortgage rates are climbing. The Mortgage Bankers Association changed its forecast for commercial and multi-family borrowing and mortgages for 2022 to project an 18% drop from $891 billion in 2021 to $733 billion in 2022.
“If delinquencies increase too much, beyond what lenders have for their acceptable range of losses, they can tighten their underwriting. It’s likely that consumers will still be able to get financing, but it will cost more, even beyond the increase due to the Fed’s rate hike,” said the vice president of research and advisory. financial services at Trans UnionMichele Raneri, said CPE.
Raneri went on to say that if this rate increase is effective, the market will see fewer sales, which will in turn influence lower prices.
“At the end of the day, there are fewer products available for financing. It is likely that there will be a continuous revision of prices on [development/construction financing, redevelopment, refinancing] so that capital can be traded,” Mark Ritchie, director of Portico Told CPE. “What we cannot forget is that the last 10 years have been an interest rate anomaly and experienced and savvy traders should be able to navigate the current environment.”
Ritchie continued to say that debt capital is abundant for the CRE industry and we moved from yield on debt to debt coverage ratio. “Throughout 2022, we have been in a ‘hot environment’ when it comes to rising interest rates. This is a continuation of the activities that started at the beginning of this year. It’s just much “hotter” when it comes to interest rates. For acquisitions, we are in a price discovery environment, especially since 2021 cap rates do not allow financing to be accretive in the current interest rate environment. The challenge for those who need to take on debt is to fully understand the realities of today’s debt capital markets.
Projects originally slated for sale are now being refinanced, as selling one property and then moving to another with a higher mortgage is not ideal. CRE can expect to see fewer sales going forward as owners will continue to sell at what they see as below-market rates, while buyers will likely wait for values to correct. According to Axford, this suggests a decline in transaction volume in 2024 through the fourth quarter as well as early 2023.
“All financing transactions will be more difficult. As rates rise, the cost of financing construction projects becomes more expensive and can make the whole project more expensive,” Paul Rahimian, CEO and Founder of Parkview Financial Told CPE.
Impact on the main types of goods
Although the number of sales may decrease, some sectors such as industrials and life sciences may remain strong. A record 551 million square feet of industrial space was taken up in the 12 months to April, according to Marcus & Millichap.
The office market has largely adapted to a post-COVID work-from-home landscape, with a large number of vacant spaces. With employees wanting to stay home, partially impacted by exponentially high gas prices, office space poses a risk to landlords and investors. “Office is facing headwinds from external forces and any non-inflation-protected assets have been negatively affected,” Ritchie said.
“Every aspect of the market will be impacted to some degree, and we see the main differentiation being by quality – of asset and location – rather than necessarily by sector. That said, sectors with growth drivers strong structural sectors – e.g. city logistics and life sciences – and therefore less dependent on cyclical demand growth, will hold up better, but rising risk-free rates and funding costs are likely to affect most aspects of the market to one degree or another – when interest rates rise 300 basis points in just six months, very few sectors of the market will be immune to any degree of repricing,” said axford.