Rising Interest Rates Impact Real Estate Investing
July 1, 2013 by Stephen C. Counts
Due to the Federal Reserve buying mortgage bonds, interest rates have been 100 to 200 basis points lower than they should have been over the past year. The Fed is limited in how long they can keep buying bonds and they have indicated as soon as economic conditions start to improve, they will discontinue the quantitative easing.
This has occurred over the last few weeks and I feel it is safe to say we have seen the bottom in interest rates. The market right now is adjusting itself and pricing mortgage bonds where they should be without Fed intervention. The stock market and investor sentiment is up, but there is strong concern of rising interest rates.
Even though investors are becoming more confident in the stability of the market and the economy, they are faced with the aftermath of several turbulent years. What does this mean for commercial real estate investors and how can they prepare for rising interest rates?
Interest rates affect capital flows and the supply and demand for capital and investors' required rates of return on investment. Therefore, interest rates will drive property prices in a variety of ways. Rising interest rates can also raise issues from the standpoint of companies; many now have higher interest payments to make if they have floating rate payments.
That can raise new questions with respect to credit risk, with respect to those companies. It ultimately depends on an individual or company’s goals as to how they will be impacted. In my opinion it is never going to be a better time to lock in long-term debt. The average interest rate over the past few decades has been closer to 9%. I anticipate we will see an increase in interest rates, but it should take some time before we hit 9% again.
Over the past few years there has been a flight to quality and credit, which has suppressed cap rates significantly for these types of assets. As interest rates increase, it will put upward pressure on cap rates for stabilized quality/credit properties. My personal opinion is I don't think we're going to see a drastic or quick rise in interest rates, but we will see them correct to normalized levels.
The largest negative impact will be seen in long term, low yielding, and high credit-quality properties. The more you navigate out of that environment, the less impact you'll have, keeping the lease terms shorter and looking at value-add investment properties is an opportunistic strategy. We will most likely see an increased appetite from investors seeking higher risk / higher yield investments going forward. It is evident that we are in a recovery and landlords will not have as much fear of lease expirations when their property is at or below market rents, especially when rental rates are on the rise.
In conclusion, if you intend to sell a CVS with 10+ years remaining on the term, now would be the time to do so. However, if you intend to buy a value-add shopping center with debt, there will most likely never be a better time to go ahead and pull the trigger. The most important thing as an investor is to be appropriately allocated for your risk appetite and yield goals.
One thing we know is long-duration, low-yielding, and high-credit-quality properties are going to be affected by rising interest rates. The question is, how much of your portfolio is going to be affected? That said, each portfolio and property is unique and has its own set of moving parts. It is important to consult a commercial advisor before making any significant decisions regarding your investments. There is serious risk in searching for yields, and people may not understand all of the danger in their investments.
Stephen C. Counts is a third generation Florida real estate broker. During his career, he has been instrumental in the valuation, consulting, and brokerage of more than $550 million in commercial properties, mainly located throughout the southeast. You can reach him at 850.832.9956.
The McCall Counts Commercial Group of Counts Real Estate, works throughout the southeast and is headquartered on the Gulf Coast of Florida. They provide the following services: Investment, Brokerage/Leasing, Private Equity, Development, and Consulting. For more information visit www.countscommercial.com