The Interest Rate Hike: What it Means for Commercial Real Estate

February 15, 2016
Written by: Amanda Marsh, CREW New York

If you’ve been lying awake at night since the Fed announced it was raising interest rates in December, rest your weary head — the decision actually sends a positive message about the market, given there’s been talk about a change for about a year and investors have baked that expectation into pricing.

“Everyone was waiting, which created a sense of uncertainty in the market,” said Cushman & Wakefield executive managing director and CREW Dallas member Beth Lambert, who’s charged with structuring debt and equity financing across a variety of product and lender types. “It sends a message to the real estate community that interest rates are better aligned with economic indicators, such as profits and jobs, and a good sign that the economy is on solid footing.”

Although the Fed’s forecasted rates look aggressive, the base rate is still at an extremely low level and won’t necessarily filter through to mortgage rates, added Savills Studley chief economist and CREW New York member Heidi Learner. And if we continue to see volatility in equity markets and commodities, we may actually see a flight-to-quality effect in commercial real estate.

The overall initial interest rate increase was smaller than estimated, Lambert continued, as it’s usually along the lines of 50 basis points.

“So you won’t see a knee-jerk reaction from investors in the short term, and the long term outlook for interest rates will show a gradual increase over time,” she said. “As we go forward, we’re still going to be in a low interest rate environment for a while, so it is still a good time to utilize refinancing to your advantage.”

This is particularly true for the myriad of debt coming due throughout 2016 and 2017, and Lambert expects a high volume of refinancing and recapitalization activity. And while REITs have taken a hiccup in the stock market and may approach the market more cautiously this year, she doesn’t expect the overall lending market to slow.

HFF senior managing director and CREW Houston member Susan Hill, who’s focused on debt and equity transactions throughout the southern U.S., noted that she has many clients consider prepaying loans because it makes financial sense.

“There are several reasons to consume capital now, but the primary reason is many in the industry believe you will see an increase in spreads in the last half of the year as lenders contemplate the negative impact the banking regulations will have at year end,” she said.

On the investment side, there is still a lot of money in the game for acquisition, and lenders will compete to capture their share of the market, Lambert noted, particularly among the life companies and banks, which have aggressive targets for the new calendar year and are seeking deals to underwrite.

But Hill expects fewer buyers of CMBS bonds or the investors buying the B-piece due to the risk retention requirements that go into effect December 24, 2016.

“This has many CMBS professionals on edge,” she explained. “Many of the life companies that were buyers of these bonds cannot be buyers going forward due to the perceived lack of liquidity.”

Furthermore, we are currently seeing life companies reevaluate their spreads and increase them, depending on how other lenders are pricing deals in the market place.

“All of this will be sorted out this year, with plenty of liquidity for commercial real estate but with the expectation [that] the volatility in the market will remain,” Hill said. “This is why it important for clients to stay educated on the market and have a broad base of lending relationships.”

The more important metric to keep an eye on is the spread between the 10-Year Treasury and the corporate bonds, which has increased 220 basis points over the past year and has everyone looking at comparative investments, she continued.

“Corporate bonds are more liquid than real estate investments and provide an alternative investment for many of the commercial real estate lenders,” she said.

Another factor that will impact real estate more than the interest rate hike is the FDIC and Treasury’s warning about laxness in underwriting standards. There has been a general easing with certain risk management practices, which has led to greater underwriting exceptions, Learner pointed out.

“They’ve sent a warning note that perhaps banks shouldn’t be easing up so much on commercial real estate as they have been,” she noted.

But this will be balanced with some positive developments, such as Congress passing changes to the Foreign Investment in Real Property Tax Act (FIRPTA) in December, which will now allow foreign pension funds to be treated the same as domestic funds on gains in real estate and makes the U.S. a more attractive development.

Another plus is the weakness in emerging market currency, such as in China. Learner said that while U.S. dollar purchases are now more expensive than they had been, Chinese investors who fear further yuan depreciation may benefit from the strengthening dollar. 

Amanda Marsh is the founder of Buzzmaestro, which provides business writing, editing, and consulting services to real estate and other industries. Previously, she was a commercial real estate journalist with Bisnow and Commercial Property News. She has been a member of CREW New York since 2015, and serves on her local chapter’s Communications Committee, as well as CREW Network’s Communications and Editorial Committee.