Rising interest rates and inflation are fueling developments in real estate markets

From the fourth quarter of 2020, buyers and sellers of commercial real estate moved away and began to fuel an impressive rebound in investment sales as many pandemic-related lockdowns and restrictions eased or took hold. end. The rush to buy durable assets peaked a year later when commercial property sales hit a record $362 billion in the fourth quarter of 2021 alone, according to Real Capital Analytics, part of MSCI Real Assets which tracks real estate transactions of $2.5 million or Suite.

Market strength continues this year: $170.8 billion in deals were closed in the first quarter, a 56% year-over-year increase, reports Real Capital. First-quarter buyers also pushed prices up 17.4% from a year earlier, according to Real Capital’s Commercial Property Price Indices (CPPI).

But given rising interest rates and other recent headwinds, will investors continue to see robust investment activity and push prices higher? The 10-year Treasury yield has climbed some 150 basis points to around 3% since the start of 2022, and 10-year fixed mortgage rates between 3% and 4% have risen around 100 basis points. For short-term variable loans, the benchmark guaranteed overnight funding rate (SOFR) was reduced from 0.05% to 0.8%.

Gisella Haidar

Gisella Haidar,
Global NAI

Meanwhile, an annual inflation rate at its highest level in 40 years and a 1.4% decline in GDP in the first quarter add more uncertainty to the market. In addition, in March, the 2-year/10-year Treasury yield curve briefly inverted. These indicators signal that significant changes are coming to the commercial real estate sector, suggests Gisella Haidar, senior vice president of the Capital Markets team at NAI Global in New York.

“Usually an inverted yield curve is a pretty good indication that we’re headed for a slowing economy,” she says. “Who knows if it will happen in two months, three months or six months. But coupled with high inflation, I think it will definitely impact commercial real estate investment and cap rates.

Cap rate compression is not discouraged

So far, however, cap rates for most property types have continued to compress, according to CBRE’s U.S. Capital Markets Report for the First Quarter of 2022. While the price increase reflected in Real Capital’s index represented a 170 basis point deceleration from Q4 2021, equity funds and lenders still have a lot of capital to put to work, says Capital Group Vice President Aaron Porter NAI Global Markets in Nashville, Tennessee. Additionally, the relative attractiveness of commercial real estate versus equities amid large losses in the stock market over the past two months continues to attract investors, he adds.

At the same time, the Federal Reserve’s 75 basis point hike in the benchmark federal funds rate so far this year, along with strong indications that it is committing to more hikes, is convincing many buyers to act now, he said. Porter also predicts that the market will begin to see the real impact of Fed actions over the next six to 12 months or so as loan demand slows.

“Investors are looking to get permanent funding as quickly as possible today because they understand the Fed is going to keep pushing interest rates higher,” Porter said. “The market is still hot for stable assets, especially industrial, multi-family and medical office buildings. But the higher interest rates rise, the lower the potential return.

Lenders make adjustments

Indeed, in light of higher interest rates, Haidar and Porter predict that lenders will require borrowers to provide more capital to secure funding, especially if cap rates do not adjust significantly. . Moreover, while lenders were comfortable allowing full-term payment periods or other generous interest-only payment periods for stabilized assets, they began to limit the provision except for highest-quality properties that are fully occupied and have strong cash flow, Porter adds.

“When interest rates were low, lenders were quite confident in the borrower’s ability to repay and were more lenient,” he says.

So far, market developments have not resulted in a change in the assets or strategies that investors favor or their ability to close deals, Haidar points out. She primarily works with value-added and distressed investors in the secondary and tertiary markets, although the supply of opportunities remains stubbornly low.

The hybrid working model that many companies are adopting continues to make office investments more difficult, say Haidar and Porter. Like many business districts, Manhattan still suffers from low office utilization rates, especially in older Class B and C properties.

“There’s a huge question in our industry right now about how to get people back into the office,” Haidar says. “And I think the answer is that you win them back by giving them an experience that they don’t have at home. It means giving them the best amenities in a place where they can feel comfortable, and as a result, we are clearly seeing a flight to quality.

Towards a dead end

Regardless of the type of property or the strategy pursued by buyers, those who need to take on debt should expect interest rates to climb to around 6% or more by the end of the year. year, if not earlier, predict Haidar and Porter. Such a large increase should eventually put upward pressure on cap rates, but it remains to be seen how far and how fast they move.

“The variable at this point becomes buyer and seller,” Porter explains. “Buyers will want to acquire offers at a cap rate of 7 or 8%, while sellers are used to seeing offers trading at a cap of 6 or less. At this point, I think sellers will just hold on to properties because they won’t get the prices they’ve grown accustomed to.

— By Joe Gose. This article was written in collaboration with NAI Global, a content partner of REBusinessOnline. For more articles and news on NAI Global, click here.

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