COMMENT: No cause for panic after interest rate increase

After months of speculation, the US Federal Reserve finally raised interest rates in a move that surprised few in the real estate world – or in the economy as a whole

Wednesday’s decision, unanimously approved by the Federal Open Market Committee, set the updated target range for the federal funds rate at 0.25 percent to 0.5 percent, up from zero to 0.25 percent. By the end of next year, the rate is forecasted to be 1.375 percent, based on the median number from 17 policymakers.

The Fed’s decision was widely anticipated. Because the FOMC noted “only gradual increases in the federal funds rate” in the future, the long-term effects of this policy likewise will be muted.

Policymakers have pointed to a sustainable recovery worldwide, particularly in developed countries, as the impetus for closing a period of unprecedented low rates. This recovery holds true in the private equity real estate world, giving investors, fund managers and developers little cause for concern. Subsequent rising rents should soften any repercussions for property from rising rates in the western world, and the Fed’s move is partially offset by continued quantitative easing in Europe. Most real estate pricing globally has already factored the quarter basis point hike into account.

The quarter-point increase may affect Chinese currency depreciation, however, pressuring capital reserves and limiting the People’s Bank of China’s ability to cut interest rates further. But any Chinese yield decompression in 2016 is more likely attributable to oversupply and domestic economic issues rather than monetary policies across the Pacific.

Real estate thought leaders have long played the ‘what if’ game for interest rate hikes, but the worst-case scenarios have yet to materialize. Some are still speculating about the potential for domestic home prices to fall sharply if rates spike in 2016, but that idea remains predicated on a big ‘if’ spike. Fed chair Janet Yellen has discouraged such speculation, using words such as ‘gradual’, ‘normalization’ and ‘evolve’ to point to a trajectory of slow and steady increases.

Commercial property cap rates are not expected to increase in tandem with interest rates, and indeed the bigger threat to those is shifting investor sentiment, not the Fed’s monetary policies. Again playing the ‘what-if’ game, if investors move toward more conservative investments in cash and high quality fixed income after some sort of currently-unpredictable macroeconomic shock, the related capital flows would impact cap rates more than any small interest rate increases will in the foreseeable future.

Barring a black swan event, currently strong international capital flows into the US and large pools of domestic pension funds’ money will outweigh any increase in the cost of capital tied to slowly rising interest rates. The pace of worldwide real estate growth is likely to slow, but that has as much to do with macroeconomic headwinds as with interest rates.

And so, private real estate investors can sleep well over the holiday break, secure in the Fed’s predictable and barely perceptible interest rate increase.