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The Good, Bad, and Ugly of Higher Interest Rates on Real Estate

March 9, 2022

In the last several months the most pressing economic issue has been inflation. The real rate is now above 7.0% and the core rate stands at 5.5%. The hike in the inflation rate for energy has been staggering at 29.3%. The preferred rate from the perspective of the Federal Reserve is around 3.5% for real inflation and 2.0% for the core. The difference between the two is that core doesn’t take into consideration the prices in energy and food as these are highly volatile categories and that complicates year over year or month over month comparisons. When rates reach this point the Fed is expected to take action to bring them down and the major tool at their disposal is the Fed Funds Rate.

The statements from the Fed thus far indicate a commitment to hiking rates three times this year, likely by a quarter point each time and starting in March. If the stated goals remain intact the interest rates will be at .75% by year’s end as compared to the current rate between 0.0% and .25%. If the Fed decides on half point hikes the rates might be at 1.5%. These will still be very low as compared to past years but these rock bottom rates have been in place since the recession of 2008 and many have become accustomed to them at this low level.

Higher Rates

The argument for higher rates generally centers on inflation control. The logic is that inflation is fueled to a degree by too much money in the economy overheating the system. The money supply issue was a bigger factor last year when the US was sitting on almost $3 trillion in excess savings due to the stimulus spend. There are other reasons to want interest rates higher and this point has been made by the “hawks” at the Fed.

There is generally a negative attitude toward higher rates, assuming hiking them will be bad for business, but there is a silver lining. When rates are as low as they have been for the past decade, the banks have little margin to work with and become cautious regarding loans. The interest rate hike will allow banks to do deals they might not otherwise consider. The bottom line is that hiking rates a little makes sense in the current inflationary environment and the hikes may also provide stability in the market as well as opportunity for business and consumers in search of bank financing.

Real Estate

For the last several years there have been contradictory trends in real estate – commercial or residential. On the one hand mortgage rates have been extraordinarily low and that has been the same situation when it comes to commercial property (although there has been considerably more variation depending on the project). At the same time prices have been much higher. The fact is many buyers (residential and commercial) pay more attention to the monthly payments than to the size of the loan. As long as rates stayed low, they were able to justify and handle the higher prices. 

Now that situation seems slated to alter as mortgage rates rise at the same time that prices continue to increase. The complicating factor as far as commercial development is concerned is there are significant differences between sectors. At the moment there is intense interest in anything related to warehousing and logistics but relatively little interest in developing office space. Retail has also suffered as has lodging and entertainment. As usual the location of a project matters with some states recovering old patterns faster than others. As interest rates rise, some of these projects will yield inadequate returns, but by the same token the higher rates make banks slightly less risk averse.

MarksNelson’s real estate team is keeping a close eye on the current trends in the market. Our team can help at all stages of the real estate life cycle — pre-development, development, management, and exit strategies. Please feel free to reach to us today for help.