Call it uncanny timing, but the start of the PREA Spring 2014 conference this week coincided with Janet Yellen’s first meeting as chairwoman of the Federal Reserve chairman. What do these two very different gatherings have to do with each other? At its meeting, the Fed made its third reduction – more commonly known as tapering – in its bond-buying program. Meanwhile, the potential impact of tapering on the commercial real estate market was the theme of the two-day event in Boston.
Those attending the PREA conference should have walked away from it with three important factors on their minds: what tapering and the rise in interest rates it will almost certainly trigger means for private real estate investment; what it means for divestment; and what it means for providers of real estate debt.
At her meeting this week, Yellen said that the Fed could potentially start raising interest rates from its current 0 to one-quarter percent target range about six months after the end of the quantitative easing program. PREA speakers had differing views on how fast and high those rates, which follow 10-year Treasury yields, would rise. Broadly speaking, however, most did expect the yield on 10-year notes to reach somewhere in the 3.5 percent to 4.5 percent range within the next two years.
Exactly what this will do to real estate practitioners and their businesses depends on what it is they're focused on. For those looking to invest equity, talk of higher interest rates comes at a time when core markets are already frothy, which suggests you’re increasingly better off placing your capital elsewhere. As a head of research at one global investment manager put it: “Certain kinds of real estate are getting hammered. Net-leased, flat bond-like deals, forget about it. That’s destruction.”
He proceeded to explain that in light of this, he intends to play the market by seeking out investment opportunities where net operating income (NOI) growth can keep pace with the bond market. This means focusing on major cities with youthful demographics and the potential for value creation on the secondary or tertiary, or fringe, neighborhoods of those urban areas.
Secondly, there’s the sell-side to consider. As another speaker pointed out, the rapid inflows of foreign capital into US real estate were creating compelling opportunities to exit. “I think there’s an opportunity in 2014 to shed the properties that have weaker NOI growth prospects, and to focus on where a strengthening economy is most likely to boost NOI growth,” the economist said.
And thirdly, the impact of tapering is giving providers of real estate credit plenty to think about too. “On the debt side, it’s music to our ears,” said David Gillan, head of global real estate investments and commercial lending at the New York State Teachers’ Retirement System. Given an anticipated $1 trillion in non-bank commercial mortgage maturities overlapping with the end of the Fed’s buyback program, “we’re hoping there’s an opportunity for us as a lender.” Beginning in the second half of this year, the pension plan hopes to originate more fixed-rate mortgages in conjunction with increasing its floating-rate exposure through its third-party bridge and transition loan strategies.
All told, the fast-approaching end of QE as we know it on private real estate in America will bring with it three important points to think through – and all of them require managers and investors to keep pace with the changing times. Maybe it goes without saying, but business as usual will not be an option.