The Federal Reserve Bank in Washington DC

WASHINGTON, DC–December only saw 156,000 jobs added to the nation's payrolls, according to the US Labor Department, along with a slight uptick of the unemployment rate to 4.7%, from 4.6%. The number of jobs created last month were somewhat less than expected with economists expecting around 175,000 positions. The kicker, though, in this morning's report is this: Average hourly earnings increased 10 cents or 0.4%, following a 0.1% drop in November. The year-on-year increase in average hourly earnings was 2.9%, the biggest jump in seven years. Translation: wage growth is speeding up, perhaps faster than expected.

In the past, lackluster economic news caused the Fed to hold off on monetary policy changes. This time, though, it is highly unlikely the Federal Reserve will start dithering again on its plan to raise the federal funds rate . With wage growth comes inflation and one of the markers, or signals, the Fed has been looking for is inflation growth.

And inflation – while still low – has been creeping up on a seasonally-adjusted basis.

Not surprisingly, we can expect this shift in macroeconomic fundamentals to change the dynamics in commercial real estate investment. But it may not be as dramatic a shift for the industry as some might expect.

It was clear even before this morning's report that the industry is entering a new phase based on a rising interest rate environment. JLL Research Director Scott Homa notes that the 10-year Treasury — the key benchmark for real estate valuation of course — has risen approximately 60 basis points since the election.

“We need to see a commensurate increase in rents, or decrease in spreads, to offset this dynamic,” he told GlobeSt.com shortly after the New Year. “The problem is that net effective rents have not grown for the better part of the past decade, so it will be essential that net operating income rises in tandem with those increases in interest rates.”

One plus that is likely to work in the office sector's favor is the recent bump we've seen in the equity markets, he says. “Institutional investors typically allocate a certain percentage of assets under management to real estate – averaging around 10% on balance – so it's likely that we'll see larger pools of capital seeking buying opportunities in the office sector. This has the potential to keep overall pricing stable, or even trend upward, despite the recent rise in interest rates.”

And while rising interest rates also mean more competition for commercial real estate assets — there are other higher-yielding assets to compete for investors money now — Sandy Paul, NGKF's Managing Director of National Market Research, believes that commercial real estate will continue to yield a higher return in 2017 than other major asset classes, even though rising interest rates may create a drag on returns.

“The significant recent run-up in stock valuations and the major policy unknowns of the new administration suggest that there will be notable volatility in the equity markets during the first half of 2017, dampening returns on stocks – even if some tax policy changes are friendly to major corporate interests,” he tells GlobeSt.com.

“Similarly, a rebalancing of portfolios by institutions is likely to continue the trend of increasing allocations toward real estate, given the need to manage risk on stocks.”

And as for the augur of inflation, that couldn't be better news for CRE investments. Real estate is an inflation hedge, so accelerating inflation in 2017 likely would spur additional investment in commercial real estate, increasing values and also returns, Paul concludes.

The Federal Reserve Bank in Washington DC

WASHINGTON, DC–December only saw 156,000 jobs added to the nation's payrolls, according to the US Labor Department, along with a slight uptick of the unemployment rate to 4.7%, from 4.6%. The number of jobs created last month were somewhat less than expected with economists expecting around 175,000 positions. The kicker, though, in this morning's report is this: Average hourly earnings increased 10 cents or 0.4%, following a 0.1% drop in November. The year-on-year increase in average hourly earnings was 2.9%, the biggest jump in seven years. Translation: wage growth is speeding up, perhaps faster than expected.

In the past, lackluster economic news caused the Fed to hold off on monetary policy changes. This time, though, it is highly unlikely the Federal Reserve will start dithering again on its plan to raise the federal funds rate . With wage growth comes inflation and one of the markers, or signals, the Fed has been looking for is inflation growth.

And inflation – while still low – has been creeping up on a seasonally-adjusted basis.

Not surprisingly, we can expect this shift in macroeconomic fundamentals to change the dynamics in commercial real estate investment. But it may not be as dramatic a shift for the industry as some might expect.

It was clear even before this morning's report that the industry is entering a new phase based on a rising interest rate environment. JLL Research Director Scott Homa notes that the 10-year Treasury — the key benchmark for real estate valuation of course — has risen approximately 60 basis points since the election.

“We need to see a commensurate increase in rents, or decrease in spreads, to offset this dynamic,” he told GlobeSt.com shortly after the New Year. “The problem is that net effective rents have not grown for the better part of the past decade, so it will be essential that net operating income rises in tandem with those increases in interest rates.”

One plus that is likely to work in the office sector's favor is the recent bump we've seen in the equity markets, he says. “Institutional investors typically allocate a certain percentage of assets under management to real estate – averaging around 10% on balance – so it's likely that we'll see larger pools of capital seeking buying opportunities in the office sector. This has the potential to keep overall pricing stable, or even trend upward, despite the recent rise in interest rates.”

And while rising interest rates also mean more competition for commercial real estate assets — there are other higher-yielding assets to compete for investors money now — Sandy Paul, NGKF's Managing Director of National Market Research, believes that commercial real estate will continue to yield a higher return in 2017 than other major asset classes, even though rising interest rates may create a drag on returns.

“The significant recent run-up in stock valuations and the major policy unknowns of the new administration suggest that there will be notable volatility in the equity markets during the first half of 2017, dampening returns on stocks – even if some tax policy changes are friendly to major corporate interests,” he tells GlobeSt.com.

“Similarly, a rebalancing of portfolios by institutions is likely to continue the trend of increasing allocations toward real estate, given the need to manage risk on stocks.”

And as for the augur of inflation, that couldn't be better news for CRE investments. Real estate is an inflation hedge, so accelerating inflation in 2017 likely would spur additional investment in commercial real estate, increasing values and also returns, Paul concludes.

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Erika Morphy

Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.