SAN FRANCISCO—The US economy passed a major psychological threshold last week as the Federal Reserve closed the door on the extraordinary measures put in place to combat the financial crisis. With the quarter-point increase of its overnight lending rate, the Fed signaled that the economy has finally returned to normal operating levels. Though some sectors still face headwinds, broader economic measures including employment, retail sales and even home prices have largely returned to healthy performance standards, says John Chang, first vice president of research services at Marcus & Millichap. The Fed reiterated that it will maintain a gradual pace of rate increases, aligning actions with key indicators such as labor market conditions, inflation and international developments.
While short-term lending will be influenced by the Fed's move, long-term interest rates will face little upward pressure in the immediate future. As 2016 progresses, the cost of long-term debt could see upward pressure, but this will be influenced as much by domestic and international confidence as by the central bank's actions, says Chang.
Ken Rosen, chair of the Fisher Center for Real Estate and Urban Economics at the University of California Berkeley's Haas School of Business, tells GlobeSt.com: "The Federal Reserve rate hike was expected by the market and we expect three more increases in 2016. In parallel, real estate mortgage rates will also continue to increase by a similar amount."
Chang says a solid pace of household creation accompanies an economic expansion and will generate new demand for apartments in the near term. US apartment vacancy will fall this year to 4.2% and will rise nominally in 2016 as elevated completions narrowly outpace net absorption. Also, the Fed's benchmark rate most directly affects consumer borrowing for items that include residential mortgages. Any additional tightening in monetary policy that suppresses single-family home purchasing and maintains a low rate of homeownership will provide a supplemental lift for the multifamily sector.
The move by the Federal Reserve will likely benefit commercial real estate investors, more because of the message it conveys than the influence of the rate change itself. By raising the rate for the first time since 2006, the Fed has finally expressed its confidence in economic growth, potentially opening the door to increased consumption and business investment. These positive trends would benefit all commercial real estate sectors as household formations escalate and increased discretionary income supports demand for housing, retail goods and business services, says Chang.
The tempo and sustainability of economic growth that swayed the central bank represent a decidedly positive development for the office sector, and industrial properties will also benefit from this trend. Additional hiring will generate new office space demand and put downward pressure on vacancy. Also, incremental demand may also emerge in interest-rate-sensitive financial services businesses, contributing to a projected decrease in the US vacancy rate next year. In the industrial sector, a more robust pace of economic growth stemming from higher consumption will stimulate additional space demand from retailers. The rate increase will likely also strengthen the dollar, restraining US companies with significant export business, according to Marcus & Millichap.
However, Rosen points to companies revaluating write-offs, which is not proving successful. When this capital evaporates, it could lead to lessening job growth, followed by sublease space and rent reductions, "I wouldn't be surprised to see a 20% drop in commercial real estate values (if revaluations continue)," he tells GlobeSt.com.
Rosen further cautions about the pace at which the commercial real estate market has been operating, saying so much growth is "not sustainable." He tells GlobeSt.com: "The interest rate increase is part of the anticipated correction process, which will lead to a modest growth reduction."
As previously reported, the increase will have little short-term impact as the Fed determines the timing and size of future adjustments to the target range for the federal funds rate.
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Lisa Brown
Lisa Brown is an editor for the south and west regions of GlobeSt.com. She has 25-plus years of real estate experience, with a regional PR role at Grubb & Ellis and a national communications position at MMI. Brown also spent 10 years as executive director at NAIOP San Francisco Bay Area chapter, where she led the organization to achieving its first national award honors and recognition on Capitol Hill. She has written extensively on commercial real estate topics and edited numerous pieces on the subject.
