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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.