Impact of Rising Interest Rates on Commercial Real Estate Values
Although 2017 looks to be a year of significantly more uncertainty for investors, one thing that everyone seems to agree on is the likelihood that the Fed will finally raise interest rates. While this change in posture has long been expected, many investors in the real estate sector are worried that rising rates will signal an end to the recovery in commercial real estate that has now lasted longer than 25 quarters.
But while these fears are common during times of rising rates, the truth is somewhat more complex than that. While there is a correlation between rising interest rates and property capitalization rates in the commercial real estate sector, that correlation is far from perfect: in reality, a number of different variables influence cap rates beyond just the Fed rate.
Many of these factors may provide protection for commercial real estate investors in the current environment. For one thing, a decision by the Fed to raise its rate is itself reflective of the board’s expectation for increased employment and economic growth in the near future. In the case of the current environment, unemployment figures have dropped below 5%, and the tightening labor market is finally beginning to yield wage gains for American workers. Commercial properties are expected to benefit from increased job growth with higher occupancy rates, rent, and NOI growth. In fact, most indicators point toward continued positive growth for the commercial real estate sector in the near term.
Thus, while rising interest rates may provide some headwinds, other fundamentals continue to look positive for the sector.