Recently I was asked to speak at a conference of fund managers whose chief focus was high net worth families, and even in that scenario the recurring questions were:
- How will rising interest rates affect real estate investment?
- Is this action to raise rates by the Federal Reserve a harbinger of new problems in the commercial real estate world?
The Federal Reserve recently raised interest rates for the first time in 10 years, but only by a quarter of a percent (25 basis points). The Federal Reserve uses its power to raise and lower interest rates on money it lends to the U.S. Banking System as a way of making credit more or less expensive, which in turn is a tool to control inflation and to expand or contract the economy.
In this case, they are not raising rates to restrain the economy or control inflation. On the contrary, they see the economy slowly growing and the jobless rate slowly going down, and this small rise in the interest rates, which was forecast for many months, is a way of giving the Federal Reserve a tool to work with in the future.
In a sense, they fired all of their bullets when they reduced interest rates to nearly zero and bought back billions of dollars in bonds. This recent modest increase is a way of ‘reloading’ without hurting the economy so they can continue to reduce interest rates to stimulate the economy when needed in the future.
If we had a dramatic rise in interest rates, that would drive investment capital into the bond market to find higher returns and would drive investment equity away from real estate and stocks – which would be problematic at many levels.
High interest rates can also drive up real estate cap rates, resulting in lower values. In this case a very slow and moderate rise in interest rates is an indication of a strong, growing economy, which translates into higher occupancy in office, retail, industrial and multifamily rental properties, as well as strong job growth.
Long-term real estate values rise due to three factors:
- Increase in demand
- Rising replacement cost
- The flight to safety represented by quality real estate.
Investors continue to be disappointed in the lackluster stock market and the low return of bonds. We have been experiencing increased stock market volatility due to a confluence of factors, chiefly global economic and political volatility, with a particular focus on unstable oil prices and other commodities. I mentioned to this group that we simply need to anticipate and work within the parameters of an increasingly volatile world, which of course leads to increased volatility in the financial arena.
The volatile stock market doesn’t mean that the proverbial sky is falling or that the economy is crashing, but it does mean more dramatic ups and downs within shorter timeframes, particularly in an environment where global powerhouses China and Europe are experiencing serious fiscal challenges, and hedging through U.S. stocks, bonds and real estate.
While we may be facing our own financial challenges, the U.S. remains the port-in-the-storm of this particular global crisis. I can, of course, best speak to real estate investment, something I see and live with on a daily basis.
People are seeking quality investments in real estate in the U.S. to hedge against global uncertainty. We see this across all growth cities which are well-known by foreign investors, including the South Florida market.
While the strong dollar vis-à-vis the diminishing value of stalwart currencies such as the Pound, Yen, Yuan, Peso and Euro have impacted international buyers, there is clearly tremendous long-term value in real estate, particularly commercial real estate.
We see growth in emerging ‘A’ submarkets that are not overbuilt, such as Miami, Orlando, Atlanta and other parts of the Southeast.
This is a belief confirmed by our own company’s long-term strategic plan, as we continue to develop and invest in multifamily, office buildings and mixed-use communities throughout South, Central and West Florida, along with other key markets like Atlanta.
No real estate investment is a panacea, and of course no one has a crystal ball about continued low interest rates. But that said, it is our belief that interest rates will remain generationally low for the time being, which means that the ability to access reasonably priced capital will continue, helping to fuel real estate investment from both domestic and international investors.