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Another Interest Rate Hike: What's Ahead for CRE

 

The consensus was correct: The Federal Reserve has again raised interest rates. The most recent increase was smaller than the previous four consecutive meetings that resulted in a jump of three-quarters of a percentage point.

Wednesday’s meeting went as predicted, resulting in a short-term interest rate raise by half a percentage point, bringing the federal funds rate to a range of 4.25 percent to 4.5 percent. This is the highest range seen since 2007.

The decision of how much to raise rates was a reflection on the latest data on the Consumer Price Index, including wage growth, consumer goods pricing, consumer demand, housing prices and shipping costs. Fed Chair Jerome Powell also said in past meetings the Fed’s decision is impacted by the tightness in the labor market.

Experts agreed that the Fed would raise rates by 50 basis points this week. Inflation remains higher than the central bank’s goal, indicating this raise will likely not be last. Powell said in his Wednesday speech that he anticipates ongoing increases in rates.

As real estate lenders and developers adapt to the new environment, deals and transactions are slowing across most major markets. Uncertainty about how high rates will go and the impact on the economy makes it difficult to assess property values.

“The slowdown in CRE is already being felt in all segments of the market,” said Shlomi Ronen, Managing Principal at Dekel Capital in Los Angeles. “The big question is how long will it last and if there’s a potential for some easing of monetary policy from the Fed sometime next year.”

Jon Fhima, CEO of F2, noted that even with a lower interest rate hike, such as 50 basis points, the general market and developer sentiment will likely not get development back to pre-COVID level activity. “Developers still seem skittish to put shovels in the ground,” said Fhima. “Construction costs coupled with interest rates are still a little too high to palate.”

Until a sense of “normalcy” is returned to the market, CRE must navigate the uncertain future with the information given on the current economy. While certain deals are still actionable, some asset classes and property types are feeling the pressure more than others.

“Rate hikes make deals harder to get done, especially with the uncertainty with retail and office markets,” said Marc Norman, Associate Dean, NYU School of Professional Studies, Schack Institute of Real Estate. “That said, as rates increase, alternative lenders and investors’ capital becomes more competitive and more flexible.”

The rate hikes are roiling the commercial mortgage market. Rising rates increase the cost of debt for borrowers, while banks worry about how rising rates affect the value of their portfolios.

“Banks must be careful writing loans in a rising rate environment,” Paul Fiorilla, Director of Research for Yardi Matrix said. “Portfolio lenders worry that the value of the loans on their books will decline, plus higher rates could make the take-out of the loan more difficult. For CMBS and CLO issuers the problem is more acute. Although they hedge, their book loses value when rates increase between the time loans are originated and sold.”

According to Fiorilla, because the rates only went up slightly this week and may continue suit in following rate hikes, the impact on the market will be relatively small. However, should the Fed raise by another 100 basis points, lending will be discouraged as originators will have to be more conservative because they will reduce leverage and ensure debt service is sound.

Rate hikes not only impacts the future of deals in CRE due to the difficultly that may stem from trying to find financing, but also affect existing funding already in play.

“Existing loans with maturities or resets in 2023 and 2024 will feel the brunt of the rate increases and likely struggle for new financing given the triple whammy of higher rates, higher expenses and higher vacancies,” said Norman.

As the outcome of this rate hike was an increase by 50 basis points, Fhima believes general investor sentiment should be positive, as the message conveyed is that inflation is slowing. “The hope is that we’ll begin to see far greater volume and liquidity in the marketplace considering it has drastically slowed down over the last six months,” said Fhima.

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