FED TAKES PAGE FROM PAST PLAYBOOK, RAISING INTEREST RATES
Federal Reserve officially kicks off period of rising rates. On Wednesday, March 16, the Fed approved a 25-basis-point rate increase, the first since December 2018. While the hike was a bit of a reality check for commercial real estate owners and lenders alike, the main cause of concern was the FOMC’s post-meeting comments. This release verified inflation concerns and the many rate hikes that may be coming over the next year and a half to alleviate them. The Fed also indicated the possible magnitude of the rate hikes. Based on recent comments by Chairman Powell, it seems likely that the Fed will increase rates by another 50 basis points in early May, with potentially another five or more hikes resulting in a Fed Funds rate in the 1.90 percent to 2.50 percent range by the end of the year. Some forecasts expect even more rate increases in 2023.
Expected rate trajectory still below historical levels. Despite various concerns, it is important to view these rate hikes in historical context. At the pinnacle of the last real estate cycle in 2005-2006, prior to the Great Financial Crisis, the commercial real estate market was clicking away with a Fed Funds rate as high as 5.30 percent, and a 10-year Treasury Rate as high as 5.23 percent. That is still below the average 10-year Treasury Rate of 6.07 percent over the past 50 years. While the Fed Funds rate has hovered around zero for more than a decade, the planned Fed hikes will still keep interest rates at relative historical lows. It may have an impact on a market that has seen cap rates compress and construction costs rise, due to a low interest rate environment. Despite this, history demonstrates it is possible to have a strong commercial real estate market in a higher rate environment than many currently contemplate.
* Sources: Marcus & Millichap Research Services; Federal Reserve; Freddie Mac Primary Mortgage Market Survey; CoStar Group, Inc.; Moody’s Analytics; MNet; Real Capital Analytics; RealPage, Inc.; U.S. Bureau of Labor Statistics