In an article for the Huffington Post, Jorge Newbery, Founder & Chief Executive Officer of the American Homeowner Preservation LLC, says that when economy improves, commercial real estate values could dip by 19 percent. Why would such improvement lead to such a negative effect?
As Economy Improves, Fed Reserve Will Eventually Raise Interest Rates
A "strong case" of the Federal Reserve to hike interest rates this June is expressed by Richmond Fed President Jeffrey Lacker, reports Reuters. According to Lacker, improvements in the economy such as consumer spending and availability of jobs in the labor market are significant over the last year, which lead them to consider increasing rates.
"Given what we know today, a strong case can be made that the federal funds rate should be higher than it is now," Lacker said in a statement for the Greater Richmond Chamber of Commerce. "I expect that, unless incoming economic reports diverge substantially from projections, the case for raising rates will remain strong at the June meeting," Lacker added.
As Interest Rates Increase, Available Real Estate Capital for Investment Decreases
According to Investopedia, with low rates such as decreased interbank exchange rates, the "cost of funds readily flow into the system." Thus, when there's an increase of these rates, the availability of funds is also reduced.
In real estate, it means that an increase in interbank lending rates would lead to lower capital available for such investments. When capital becomes limited, "capital providers tend to lend less," as they foresee an increase in risk, and "thus, reducing leveraged cash flows" and "putting increased downward pressure on property prices," Investopedia explains.
Newbury states that the acquisition of the Willis Tower in Chicago for $1.5B just demonstrates how low interest rates allow a ready stream of capital flow into buying commercial real estate properties. Thus, he also says that the Willis Tower is a "108-story bubble" in the commercial real estate industry presently standing there. If the economy improves and rates are then set higher by the Federal Reserve to control inflation, there will be pressure for the prices of these properties to go down.
Citing Real Capital Analytics forecasts, commercial real estate values could drop from 8 percent to 19 percent, Newbury adds. It is based on the assumption that the current 2 percent "rates of 10-year Treasury bond yields would normalize at a healthier-for-all 4 percent."
Newbury notes that today, low interest rates "hasn't done the trick" and instead, it benefited the wealthy, representing 1 percent of our society by having lifted the "value of investment assets like commercial real estate." Newbury states that it is time to make the rest of the 99 percent to join the festivities, and as a whole nation, we can move forward as one.
