What the Fed’s recent hikes mean for CRE investors

The latest 50 basis point increase in the overnight rate – which brought the federal funds rate to 0.75% – was announced by economists and industry watchers last week. This, along with the Federal Reserve’s initial steps toward quantitative tightening, has investors go for a walk.

But the moves toward quantitative tightening were “well telegraphed,” according to John Chang of Marcus & Millichap, who said “It looks like Wall Street has already brought it into the market.” With that said, the Fed is making a concerted effort to control inflation again, and the CPI was 8.5% at the last reading, with a new figure released on May 11.

“Basically, inflation is at a 40-year high, and the Fed is trying to use monetary policy to rein it in,” says Chang. The idea is that by increasing interest rates, borrowing will decrease and spending will slow. This will reduce the demand side pressure that is driving prices higher.”

In response to some critics who see the Fed as behind the curve, Chang stresses that there are some challenges that the Fed did not initially anticipate.

chief among them? Perennial supply chain problems that have plagued nearly all aspects of the global economy.

“The supply chain problems haven’t gone away yet,” Zhang says. “They are in better shape today than they were six months ago, but China is still the number one producer of consumer products, and they continue with the massive coronavirus lockdowns.”

Shanghai is also the world’s largest port, carrying one and a half times more container volumes than the ports of Los Angeles and Long Beach combined – and the entire city has also been under lockdown due to the coronavirus since March 28, “so nothing has left the port of Shanghai,” Zhang says.

Core inflation factors such as oil prices, building materials, housing and wages are also rising, further exacerbating the Fed’s predicament. And although the cost of borrowing is rising, “the United States is full of money,” Zhang says, with household savings exceeding family debt for the first time in three decades. This means “it may take a while before the brakes get stuck.

“If the inflation curve does not flatten, investors should expect additional significant rate hikes to come from the Federal Reserve’s June 15 and July 27 meeting. At this point, a 75 basis point increase this summer would not be off the table.”

For CRE investors, that means looking to stash capital in inflation-resistant types of real estate like multifamily, self-storage, and hotels. Chang also says investors should plan to raise interest rates by securing long-term debt as quickly as possible, but notes that strong household balance sheets will remain a tailwind of spending on supportive real estate in the retail and hospitality sector.

Regarding pricing, “some buyers are holding back due to higher interest rates,” Zhang notes. But the demand drivers for housing and space in most types of commercial real estate still have a strong outlook, and new supply risks have been mitigated by the pandemic. This means that the underlying outlook remains strong, and rental growth will be strong for most types of properties in most areas. In addition, capital liquidity is still high, so there are many buyers and we are still in a climate of competitive bidding.”

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