Interest Rate hikes effects on Commercial Real Estate

Excerpts from a recent AP article and our comments surrounding it:

An important indicator in the U.S. commercial real-estate market is signaling that a decade long bull run is on shaky ground heading into the new year.

The gap between long-term borrowing rates and what some types of commercial properties on average yield is the narrowest it has been since 2008, according to data firm Trepp LLC.

In the past, this tightening spread has often presaged a drop in property prices, sometimes with dire results. “In 2007, looking back, that was a real red flag,” said David Steinbach, chief investment officer for Houston-based Hines.

Hines, one of the country’s biggest investors in office buildings, was a net-seller of that property type this year partly because it believes values are near their peaks, Mr. Steinbach said.

Other big investors and lenders are also reducing risk. Terra Capital Partners, a New York investment firm that specializes in commercial property debt, is offering fewer construction loans and making more first mortgages, which are safer.

Prudential Financial Inc. said it is cutting its exposure to property types that typically get hammered in a downturn—like office and fashion-oriented retail—and buying more recession-resistant property types, like housing that targets lower-income renters.

Commercial real-estate prices have increased steadily since 2009. In more recent years, as the economy has expanded, landlords also have enjoyed rising rents and falling vacancies.

But many are now thinking that prices have peaked. A Green Street Advisors value index of property owned by real-estate investment trusts increased only 2% in the 12 months ending Nov. 30, compared with the earlier years of the recovery which showed annual growth rates of as much as 20%.

At the end of the third quarter the average rate borrowers paid on loans packaged into commercial mortgage-backed securities was 5.03%.

One year earlier it was 4.52%, Trepp said. That increase “is a big deal on multimillion-dollar properties,” said Joe McBride, Trepp’s research director.

Rylee Park: As a general rule, a 1% increase in interest rates leads to a 10% decrease in purchasing power. Obviously this is a huge generalization as there are many cash purchasers, but the morale of the story is that the recent uptick in lending rates is a concern for short term asset appreciation. 

Not everyone thinks it is time to head for the exits. A still expanding U.S. economy and the amount of money sloshing around the market suggest the bull run can continue.

Investors purchased $152.7 billion of U.S. commercial property in the first three quarters {of 2018}, up 17% from the same period in 2017. 

Meanwhile, developers are building more, intensifying pressure on the supply side. JLL is projecting that this year more than 250 million square feet of industrial space will be delivered, compared with more 232.7 million in 2017.

Some major banks are also turning more bearish. Wells Fargo & Co., the country’s largest commercial property lender, has reduced its exposure to the sector to $110 billion this year, down over 5% in the past two years.

RPP: it is our contention that interest rate hikes will certainly play a role now and always in both the Real Estate and Equities markets. That said, the argument can be made that the Federal Reserve has been increasing rates recently simply as a measure to have 'bullets' in the recovery chest should the market slow down continue or increase. Given the amount of cash on the sidelines, commercial real estate and its creative 'triple net' structure will most certainly be a stable investment long term despite the short term hiccups it may encounter. This may not be true in the retail world as online stores continue to take market share, but will most certainly be the case in office/ industrial/ medical, etc on a market by market basis. 

For more information on Kirkland Commercial Real Estate, consider contacting us. You can reach me directly at Scott@ryleepark.com or via cell phone at 206.306.4034.

Scott Weitz - Designated Broker/ Attorney

Rylee Park Properties

www.ryleepark.com