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Last month, the Fed lifted the federal funds rate by 25 basis points (or a quarter of a percentage point) to a range of 1.5% to 1.75%. This move by the Fed was expected as evidenced by the near continual speculation by financial news media and business pundits in the weeks leading up to the action. The increase is the most recent of six that have been executed by the Fed since December 2015. While rates are still extremely low by historical standards, savvy commercial real estate professionals are keeping a keen eye on this activity which directly affects rates for mortgages, as well as other borrowing instruments.
Standardization and Economic Strength
Before the creation of the Fed in 1913, there were as many as 30,000 different currencies being used in the United States. As a result of this lack of standardization, the economy swung wildly, and banks collapsed regularly. The Federal Reserve was created to solve these problems and ensure a stable economy through monetary policy. It accomplishes this by changing the interest rate to stimulate economic growth and fight inflation, which it targets at about 2 percent. Any Econ 101 student can tell you that when the interest rate is low, the cost of living and the cost of capital is also low, creating the potential for an inflationary economy. If the rates are high to offset inflation, economic growth decreases and unemployment rises.
More Raises to Come
In his first address since taking over the Federal Reserve, Chairman Jerome Powell has indicated that this recent lift in rates is just the beginning. Powell indicated that he and the Federal Reserve Board are of the belief that the U.S. economy will require additional gradual rate increases. At his press conference on March 21, 2018, the chairman stated, “This decision marks another step in the ongoing process of gradually scaling back monetary policy accommodation—a process that has been under way for several years now.” Succinctly, this is just the beginning of rate increases. The case for this policy setting is supported by stimulative fiscal policy, boosts in employment and foreign growth.
Impact on Commercial Real Estate
Commercial real estate professionals, in general, are bracing for higher inflation which will require the Fed will reaching into its monetary toolbox to raise borrowing costs and reduce the risk of consumer demand running ahead of production. At a two-year high already, mortgage rates are likely to continue to rise.
The adjustments that the Fed makes are significantly small and the effects of these changes on the economy occur at a glacially slow pace by design. So, while interest rates will likely have a limited impact on real estate...for now, as the Fed continues to push interest rates up, the cost of capital will become increasingly expensive, potentially affecting pricing and availability. Some commercial property types like net lease properties are more sensitive to rate hikes and will likely be impacted sooner, however.
Smart Investors Should Be Thinking Long and Low
Many analysts speculate that there are at least two and possibly three more planned increases for 2018. While the general economic climate is strong, as suggested by the recent jobs report and consumer price index summary, these indicators track with Chairman Powell’s outlook. The Fed will react accordingly to ensure economic stability. According to a CBRE Americas Investor Intentions Survey, 88% of investors plan to either maintain or increase spending in 2018, despite concerns about the end of the current growth cycle. Only time will reveal how the CRE market will head, but investors and buyers should, at this point, be looking to capitalize on the lower-interest rates and strike long term agreements in anticipation of higher rates down the road.
Malls are activity hubs
From their very beginning, shopping malls, as we know them today, have been more than simply shopping centers, they are retail destinations. They are places where teenagers go to meet friends and ogle the windows filled with items they hope to own someday. Seniors walk their broad promenades, using the tile lined pathways like an all-season season track for accumulating their “steps” and staying connected to others in their community. Of course, the masses go for the convenience of one-stop shopping for fashions, shoes, electronics, sporting goods and the food court.
Today’s malls are not unlike the open air markets of ancient Greece or the marketplaces of medieval Europe, commonly found adjacent to cathedrals. Like their long-ago predecessors, the more than 1500 malls built between the 1950s and today are gathering places for societies.
Despite the central role that shopping malls play to communities, Credit Suisse predicts that as many as 25% of U.S. malls will be gone by 2022.
Signals of the changing retail landscape
Deadmalls are a real thing in commercial real estate. There’s even an entire website dedicated to memorializing these foregone entities with stories and photos. Deadmalls are characterized by low tenancy, low consumer traffic and a general lack of contemporary appeal. Usually, these are older malls built in the 1970s that are now struggling to compete with newer malls. But, even malls built in the last couple of decades may find it difficult to compete with those that offer more modern features and a more unique or varied set of stores.
Typically deadmalls arise from the closure of an anchor store which results in the cascading departure of other, smaller tenants that are now able to break their leases. Recently the downward spiral of brick and mortar retail has hastened this. In 2017, Credit Suisse projected that nearly 8,600 stores would close, including many of the vanguards of mall retailing like Limited, Pay-Less, Radio Shack and Sports Authority. Uncertainty surrounding retail giants Sears and Macy’s could have some additional impact this year.
A mall eat mall world
It’s easy to want to blame the fate of malls on major economic factors like declining populations, rising minimum wage and the rise of Internet-based shopping. Without a doubt, those factors are part of the story. So too are societal factors like the demand for malls to be filled with a broad spectrum of consumer-centric amenities like healthcare services, movie theaters and play areas for entertaining shopping-weary children.
A somewhat overlooked factor, however, leading to the demise of some malls, is the development of new malls contributing to the general congestion of the retail space. As proof of this congestion, it was recently reported that CoStar Realty Information estimates there is 2,353 square feet of space of shopping centers in the United States for every 100 Americans. That’s roughly twice the amount enjoyed Canadians and almost six times the amount for British consumers.
As nearby properties continue to be developed into new shopping space, a once-dominant mall will likely struggle to compete. In a specific case in Austin, Texas, million square foot Highland mall lost its J.C. Penney store in 2006, according to Morningstar. When the nearby Domain in North Austin center opened a year later, many shoppers abandoned the older mall. Eventually, Highland lost Macy's and Dillard's and was eventually closed.
The Future Isn’t Necessarily Bleak
As more malls face the pressures of retail congestion, there will undoubtedly be adjustments and a rethinking of the retail landscape. Likely, the third, fourth or fifth mall in a DMA will struggle to survive, but it may not be impossible. Building owners will need to consider alternatives uses for the space that may include medical office space, gyms, warehouses to support online retailers or re-configuring the space to attract freestanding retailers like Home Depot or T.J. Maxx. Owners of class A and class B malls will need to ensure that they're located in affluent, highly populated markets that are hubs for economic, transportation or tourist activity to continue to thrive. Additionally, backing from cash-rich operators will help to keep the mall up-to-date and adapting to the changing times.