With the Federal Reserve raising its benchmark short-term interest rate in March for the third time since December 2015 and two more rate hikes expected by the end of 2017, interest rates are becoming an increasingly relevant factor in analyzing the near-term future of U.S. commercial real estate.
Higher interest rates make borrowing more expensive for owners, which can have a constraining effect on the commercial real estate market. All else being equal, cap rates will go up and property prices will come down. Yet higher rates also typically signal a stronger economy, which tends to be associated with a stronger real estate market.
Recent surveys of business leaders found high expectations and rising optimism about the U.S. economy. Business Roundtable found the economic outlook of over 100 heads of the largest U.S. companies rose in early 2017, showing the biggest increase since the second half of 2009. And the National Federation of Independent Business found that small business owners’ optimism was near a 43-year high in February.
Yet Federal Reserve Chairwoman Janet Yellen indicated that any expectations of rapid economic growth may have to be tempered. The rate hike “does not represent a reassessment of the economic outlook,” Yellen said in a March press conference, adding that the Fed expects the economy to “expand at a moderate pace over the next few years.”
In the short term, some borrowers may be anxious to refinance sooner rather than later, given that more rate hikes are expected. The latest hike raised the interest rate by a quarter of a percentage point, to a range between 0.75% and 1%.
Higher long-term interest rates are beneficial to lenders, but they might not fully benefit from the increase due to the regulations put in place after the 2007 financial crisis, which can also help curb excessively risky lending practices.
Yet this is an unusual juncture: Interest rates are rising after a decade of low rates just as the White House is pledging to minimize regulations.
It remains to be seen whether the Trump administration will follow through on minimizing the reach of financial watchdogs and, if so, whether financial institutions will succeed in managing risk sufficiently with reduced oversight.