A Look at the Impact New Fed Activity Will Have on Real Estate Valuations
Numerous times over the past several years, rising Treasury yields have prompted commercial real estate investors to speculate how the end of historically low interest rates would influence property values. Invariably, the yields reversed course — even after the Federal Reserve Board of Governors (The Fed) began, in late 2015, to ‘tighten’ monetary policy — and allowed capitalization rate compression to continue.
Investors, however, are once again pondering the question amid the Fed’s announcement earlier this month it would begin to unwind its nearly $4.5 trillion balance sheet. The Fed also indicated it expected a steady rise in the federal funds rate in the coming years affecting the nationwide commercial real estate market – including Philly office space, Philly retail space and Philly industrial space – including a possible hike of 25 basis points in December that would take the benchmark rate to a range of 1.25 percent to 1.5 percent.
The actions are expected to move real interest rates involving U.S. and Philadelphia commercial real estate properties into positive territory, representing a “significant shift” from the negative rate environment that has fueled the recovery, according to an industry economic commentary issued in September.
This report on upcoming Fed action in relation to the valuation of national and Philadelphia commercial properties is being offered through Philadelphia commercial real estate broker Wolf Commercial Real Estate, a Philadelphia commercial real estate brokerage firm.
Real estate observers suggest while the Fed remains methodical and transparent, interest rates in the U.S. and Philadelphia commercial real estate markets will likely inch up in an orderly fashion and won’t shock the market into a credit freeze. Additionally, waves of real estate equity and debt searching for yield should continue to fuel the low cap rate environment, albeit in a choppier fashion, they add.
“If I’m a buyer and I know my return on a piece of real estate is lower than it was a year ago, but there are no better investment alternatives, what am I going to do?” was the question posed by one leading real estate finance expert.
Given the lack of an alternative, this individual added, “Eventually, I’m probably going to go into the marketplace and participate.”
Even contrarians admit it’s tough to envision what could derail the market. Even so, one such noted naysayer said his firm is more frequently turning down investment opportunities involving national and Philadelphia commercial real estate listings after assessing the property’s performance under stressed interest and cap rate scenarios.
“It’s really hard to see how this party ends,” he said. “Investors look into the future and try to see how property values will drop from 20 percent to 30 percent, but at this point nobody sees disruption. I certainly don’t see it, and I’d like to. We do better in those environments.”
While real estate experts say they don’t necessarily welcome higher interest rates throughout the U.S. commercial real estate market – including Philly office space, Philly retail space and Philly industrial space – they acknowledge the Fed needs to tighten and unwind so it has tools to use in the next recession. With that in mind, the Fed’s timing is particularly critical.
This is because the current eight-year growth in the value of U.S. and Philadelphia commercial real estate listings is less than a year away from becoming the second-longest positive cycle in the post-World War II era, a distinction that is weighing on the psyche of investors.
“The Fed is going to have to be a little bit careful about pushing too hard on interest rates relative to the underlying growth of the economy,” one expert said. “I don’t know when the next recession is coming, but I’m willing to bet we’re closer to it than we are to the previous recession.”
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