The mid-year rate hike is already baked into strategies for most investors and shouldn’t cause any major surprises or hiccups on pending deals.
It seems almost a “sure thing” that the Fed will pull the trigger on another 25-basis point rate hike this week at its June 13th meeting.
The rate hike would come on the heels of a similar bump in March that raised the Fed’s benchmark interest rate to a range of 1.5 to 1.75 percent. The bigger question for those reading the tea leaves on higher interest rates is what’s ahead for additional increases in the second half of the year, and how the rising rate environment might impact investment strategy, sales transactions, cap rates and pricing.
Implications for CRE
The mid-year rate hike is already baked into strategies for most investors and shouldn’t cause any major surprises or hiccups on pending deals. The Fed increases influence short-term debt rates, while the 10-year Treasury is used to price long-term, fixed-rate debt.
In theory, higher capital costs could result in bidders opting to pay less for properties, which could create some upward pressure on cap rates. Yet cap rates move for various reasons, with capital costs as only part of the equation. “Cap rates are more driven by one’s view of growth in the economy and growth in rents than interest rates alone,” says Steve Kohn, president of Cushman & Wakefield equity, debt & structured finance. Expectations for rising rental rates could keep pressure on cap rates in some sectors and regions.
“We have seen a bit of a slowdown in transaction volume, but we haven’t seen an upward move in cap rates over the last six to nine months as 10-year yields have essentially moved from 2 percent to 3 percent,” adds Learner. Although cap rates have moved from 2016 lows, the recent increases that have occurred have been slight. “I think a lot of investors are taking a wait and see view, not so much because of rates and what that implies for financing, but more because of the prospects for further rent growth,” she says.
Deal volume for the first four months of 2018 was down 1 percent from a year earlier, with volatility in the 10-year in April contributing to much of that decline, according to real estate research firm Real Capital Analytics (RCA). Cap rates remained largely unchanged through April, while industrial and seniors housing sectors saw further declines in cap ratescompared to 2017, with a drop of 40 and 60 basis points respectively due to high demand for those asset types.
“I think it is somewhat asset class specific, but it is fair to say that there hasn’t been an overwhelming amount of upward pressure on cap rates to date,” adds Learner.
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