Thursday, March 3, 2016

The Impact of Increasing Interest Rates on Commercial Real Estate

A senior at Ernst & Young, Maxine Hepfer has been a member the company’s Transaction Real Estate (TRE) group in Dallas, Texas, for several years. At the direction of Partner Steve Rado, TRE published an article in late 2015 that discussed the effect of rising interest rates on the commercial real estate industry in the face of imminent rate increase by the Federal Reserve (Fed).

When the Fed considered raising interest rates at the end of 2015, people generally assumed that lenders, investors, and developers in the real estate industry would suffer. This made sense, at least intuitively, because any boost in benchmark interest rates, such as Treasury bonds, typically makes all yield-oriented investments considerably less attractive.

Ernst & Young thought leaders Steve Rado, Thomas Dudney, Dan Jensen and Peter Brogan, however, determined that rising interest rates should not immediately threaten commercial real estate values for a number of reasons. Firstly, there has been no strong historic correlation between the yield on 10-year Treasuries and commercial real estate cap rates. Secondly, any federal rate hike will improve economic conditions, and improved economic conditions should drive stronger commercial real estate fundamentals. Thirdly, an increase in the federal funds rate may not have a significant near-term impact on many types of commercial real estate debt. And finally, current capital flowing into domestic commercial real estate continues to be strong.