Rising Interest Rates Will Impact Transaction Volumes

Interest rates are anticipated to rise a couple more times this year, and it has left the many wondering how the increases will impact investment activity. Hugh Seifert and Brian Krebs of Barrington Capital Corp. expect that deal volume will decline as the market adjusts to the higher interest rates—but the impact will be short-lived. We sat down with Seifert and Krebs for an exclusive interview to talk about the impact rising interest rates will have on investment activity, how they are advising their clients and which asset classes will be most affected.

GlobeSt.com: What are your client’s biggest concerns about the rising interest rates?

Hugh Seifert: The concerns surrounding rising interest rates are two-fold. The first question is “will the federal reserve institute additional increases to the fed funds rate”, and secondly, “how will this affect yields that investors are accustom to?”. From an investment viewpoint, investors will become less attracted to acquiring assets that do not produce the returns based upon the market fundamentals over the past 5-plus years. Historically, this will lead to a slight decline in overall transaction volume that will ultimately subside once a pricing adjustment occurs.

GlobeSt.com: How are you advising your clients to prepare for the increase in interest rates?

Brian Krebs: We are advising clients to take the rate hikes into consideration when looking to acquire new property. However, with that said, rates are still at historic lows and that’s important to realize and not become overly concerned. Clients that are in a 1031 exchange will be less concerned with rate movement as their focus lies with identifying an asset that will increase the security of future income and avoid capital gain tax consequences.

Additionally, several of our clients are pulling equity out of their properties through refinancing, and holding on to the cash as we begin to see the market shift. This way they will have attractive interest rates locked in long term and have purchasing power to acquire the right deal in the future.

GlobeSt.com: How do you anticipate that this increase in interest rates will impact the commercial real estate market and activity?

Seifert: Unless buyer and seller mentalities shift overnight, there will be a significant slowdown in the market as buyers are unable to find attractively priced deals, and sellers still consider property evaluations they received over the last 1-3 years to be accurate to date. It will be the role of professional investors and brokers to relay the message to less sophisticated owners that the market is shifting and that this is simply the natural cycle of the industry. If owners fail to understand this, it could have a dramatic effect on transaction volume across all property types.

GlobeSt.com: Which asset classes and capital sources will be impacted the most?

Krebs: Looking back to the start of 2017, the asset classes that have experienced the most significant decline in transaction volume are retail and hospitality. With that said, the majority of our lenders have an abundance of capital to deploy. Speaking specifically to retail investments, we are seeing stricter underwriting guidelines when it comes to franchised restaurants, both fast casual and sit down. Both corporate and store level financials will need to be satisfactory in order for lenders to get comfortable.

GlobeSt.com: How will rising interest rates impact pricing and cap rates?

Seifert: The relationship between cap rates and interest rates has always been parallel. As interest rates move up, cap rates will have to follow. This will be a crucial change that we will need to see moving later into 2018 as transaction volume depends on this correlation maintaining its stability. If interest rates continue to climb without a change in cap rates, deals will be more and more difficult to attain positive leverage.

GlobeSt.com: Interest rates are expected to rise through the end of the year. How high do you think that they will go?

Krebs: The smartest people in the financial industry will always say that it is impossible to predict the future of interest rates as they relate to the U.S. Treasuries and a variety of indexes. Given the uncertainty of actions in the current presidential party, anything could happen as foreign business relations directly affect interest rates. However, it would not be hard to imagine that there is potential for the 10yr U.S. Treasury to near 3.5% as we move later into the year. With that being said, we will have to see how lenders react to any potential increases and whether they will hold or narrow spreads in order to be more aggressive in the market.