Commercial Investment Real Estate May/June 2017 - Page 37

ommercial real estate fi nancing is still rela- tively cheap and fairly accessible. It is not very catchy, but if capital markets had a theme song, that would be it. And while that is certainly true, there also is dynamic change ahead that will keep the industry on its toes this year. Rising interest rates, a maturing real estate cycle, and U.S. President Donald Trump in the White House. These are all factors stirring uncertainty among lenders and inves- tors. The counter weights fueling optimism for another strong year of fi nancing activity are economic growth, solid real estate fundamentals, and yes, money that is still rela- tively inexpensive by historical standards. The change in administration along with a rise in the 10-year Treasury did trigger a bit of a “wait and see” attitude in the commercial real estate industry at the end of 2016. “We are really getting some mixed signals right now in terms of what the fundamentals and what our clients say, be they investors or lenders,” says Steven R. Reynolds, CCIM, MAI, president of Pinnacle Associates, a Columbus, Ohio- based commercial real estate fi rm that provides valuation and consulting services. “There are so many moving parts right now that it is going to keep a lot of people guessing on where we think things will shake out this year.” After seven years of growth, the majority of the industry agrees that the commercial real estate market is in a mature stage of the cycle. What is less certain is just how much longer the current cycle will last and what happens next. There has been a myriad of factors that has extended the good times for the real estate market, and some of them were just dumb luck, notes John Bell, managing director of Capital Markets at Transwestern in Miami. The Brexit vote a year ago came at a time when the U.S. was preparing to introduce rate hikes. However, the uncer- tainty that Brexit created in global markets prompted the Federal Reserve to keep interest rates low. The instability in foreign markets also made the U.S. even more popular for foreign investors. The increased investor demand and continued low interest rates allowed 2016 to be a pretty stable year for investment sales and lending activity. That momentum is expected to continue in the fi rst six months of this year, while the outlook for the latter half of 2017 and 2018 is less clear, according to Bell. “People are uncertain as to where the economy is going long-term. They are being cautious,” he says. CCIM.COM Impact of Higher Rates Top of mind for the entire real estate industry is how capital markets will react to a rising interest rate environ- ment. The 10-year Treasury started March at 2.36 per- cent, which represents a year-over-year increase of 50 basis points. Some analysts are predicting that the 10-year note could rise to 3 percent by the end of 2017 and 3.5 percent by mid-2018. The Fed has indicated that it plans very modest increases this year that would potentially result in two or three increases to the short-term bank lending rate of 25 basis points each. Interest rates are rising, but the overall increase for the year is likely going to be benign and may coincide with stronger economic growth, notes Lisa A. Pendergast, executive director of the CRE Finance Council. “For commercial real estate, the view is that any increase in rates and therefore cap rates, hopefully, will be offset by greater demand for real estate and higher rents,” she says. Moody’s/RCA Commercial Property Price Index shows that property prices climbed 9 percent in 2016. However, more recent research points to fl at prices and cap rates that were either fl at or slightly higher in fourth quarter of 2016, which is most likely due to a nearly 80-point spike in the 10-year Treasury that occurred during the quarter. Accord- ing to the January Green Street Commercial Property Price Index, commercial property prices were up 3 percent com- pared to the past year, but fl at in the past three months. Higher interest rates are having a differing degree of impact on pricing and cap rates depending on asset type and quality, as well as location. For example, Green Street notes that industrial posted the strongest performance, with a 2-percent increase in property prices from November through January, compared to strip retail centers and lodg- ing that were both negative at -3 percent and -1 percent, respectively, for that three-month period. Potential Volatility Many industry experts anticipate that higher capital costs will put an end to the long run of cap-rate compression. However, cap rates may hold steady in markets where there is still strong buyer demand. “On a general level, most market participants have antici- pated the rising rates for quite some time,” Reynolds says. As such, investors have already, at least partially, factored the effects into their investment decisions. May | June 2017 35