- Jason Gordon
Perhaps you’ve noticed a slow-down in the real estate markets in the last few months … more so than just the usual pause before the commercial run up to the Q4 end of year, P&L closing fever? I’m sure it depends on where you are located, which real estate segment you’re involved with and a variety of other factors. But, the current feeling amongst commercial title agents seems to be a reasonably strong headwind in a long upward pricing rise during our 10-year flight. I speculate that less capital in the market, fewer lenders with sizeable risk appetites, an overheated 10 year-long commercial run, and more conservative investment approaches are contributing to the current pause in our monstrous appetite for bigger and more exciting commercial real estate deals.
But, what about interest rates? I am certainly not an economist. I am an attorney running a bespoke commercial title underwriter with three real estate cycles under my belt over the last 20 some odd years. Conventional wisdom holds that rising interest and mortgage rates tend to be a drag on real estate markets. After all, if monthly mortgage payments are higher, less investors will be enticed to enter the market, due to affordability. This line of reasoning holds that with each quarter point uptick in mortgage rates, more buyers will be sidelined, resulting in decreasing property values.
But things are not always that simple. Melissa Reagen, head of research for TH Real Estate (a Nuveen company), emphasizes that it all depends on what is underlying the rising rates. “If interest rates are rising because of stronger economic growth, as is currently the case, real estate demand will also likely be growing.” Ms. Reagen adds that, “If interest rates are increasing gradually, and are likely to remain at or below long-term averages … real estate would likely be well positioned to benefit from such an environment.”(REITs Can Cope With Rising Rates, U.S. News & World Report, by Jeff Brown, June 18, 2018)
Secondly, when rates are higher, banks find lending more attractive to their bottom line. “Banks may have greater incentive to loan out reserves at higher interest rates, and the increased flow of additional credit would boost economic growth,” according to Sean Snaith, director of the Institute of Economic Competitiveness at the University of Central Florida. (7 Surprising Advantages Of Fed rate Hikes, Nasdaq, by Bankrate, Dec 12, 2016)
Thirdly, if interest rates are low by historic standards (as they currently are), but begin to slowly rise, it may compel both commercial and residential buyers to get off the fence. So, although it seems contradictory, the threat of rising rates in the near term can actually spur demand, bringing sellers the higher prices they seek, as their property values rise.
Finally, when the Federal Reserve Bank (The Fed) steadily raises interest rates, it doesn’t do so on a whim. After all, an important part of its charter is to maintain a healthy, stable economy. It will only raise rates when its board of governors think that the economy may be overheating, and there is a danger of high inflation. With strong GDP growth, increasing wages, a rising stock market, and historically low unemployment rates, the U.S. economy is soaring. The Fed is betting that it can control inflation through higher rates, and that the overall health of the current economy will more than compensate for those higher interest rates.
The above points are not meant to dismiss or negate the commonly held view that rising interest rates will never negatively impact the economy, in general, and real estate markets, in particular. During many economic cycles, they certainly will. But, it is important to understand that conventional wisdom may not always hold during certain periods, such as a phase of economic growth and prosperity.
More broadly, perhaps the next time a prevalent opinion is offered regarding issues related to our industry, this article may spur you on to considering divergent viewpoints.