Research Brief: Financial Markets
May 9, 2022 | Marcus & Millichap
Fed Hikes Rate as Expected; Real Estate Sustains Strong Fundamentals
Fed continues along established stratagem to combat inflation. On May 4 the Federal Reserve raised the Federal Funds rate by 50 basis points in the second of seven planned rate hikes for the year. Now at a target range between 0.75 percent and 1.00 percent, the effective overnight lending rate is expected to climb to the 2 percent to 3 percent zone before the start of 2023 if the Fed continues with this strategy. Numerous forces continue to put upward pressure on inflation. Global supply chains remain disrupted, with significant production shutdowns in China. Labor shortages persist, with only about half as many people looking for work as jobs open, placing upward pressure on wages. The Fed’s actions are a step forward relieving these pressures by raising borrowing costs.
Factors placing pressure on cap rates. Initial yields on commercial real estate compressed substantially over the past decade as investment demand increased. Further cap rate compression is less likely, given tightening monetary policy; however, property yields will likely not adjust in tandem with interest rates. Strong underlying property fundamentals and expectations for above average rent growth will likely keep the attention of many investors, slowing any upward movement. A persistent housing shortage reflects a robust need for dwellings of all kinds, while rescinded health restrictions have lifted foot traffic for retailers and hotels. Supply chain disruptions also continue to underscore the critical roles of many industrial facilities.
Strategies adjust as margins narrow. Contracting margins between cap rates and financing costs may push some investors to recalibrate strategies or widen criteria. One place investors may look to is tertiary metros, where space demand in many markets is supported by favorable demographic projections. Last year marked an inflection point, with the population of people ages 35 to 54 beginning to expand, ending more than a decade of contraction. This age range often correlates with notable gains to income and household sizes, reinforcing a pandemic-era shift to smaller metros that are more accommodating to single-family home ownership. Local commercial properties stand to benefit from this shift.
