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.
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