April 13, 2022 | James Sprow | Blue Vault<\/p>\n
U.S. inflation hit a 40-year high at 8.5% in March according to the Labor Department\u2019s announcement on April 12.\u00a0 There have been six straight months of inflation above 6%, far above the Fed\u2019s average 2% target.\u00a0 Money managers expect the core inflation rate, that removes volatile food and energy costs from the CPI, which rose 0.3% in March, to influence the Fed\u2019s decision at its May meeting to increase interest rates by a half-percentage point.\u00a0 The futures market for Federal funds shows a nearly 90% probability of that rate rise.\u00a0 Fed Governor Lael Brainard says, \u201cInflation is too high.\u00a0 Getting inflation down is to be our most important task.\u201d\u00a0\u00a0\u00a0<\/p>\n
How does the prospect of higher interest rates and continuing historically high inflation affect the value of commercial real estate?\u00a0 While these two factors alone don\u2019t determine the direction of commercial real estate values, they certainly play a large role.\u00a0 Looking at today\u2019s commercial real estate environment, we also must keep in mind other important variables such as current occupancy rates, future additions to the stock of real estate assets, and the landlord\u2019s ability to raise rents.\u00a0 These vary across the different commercial real estate asset types, meaning high inflation and rising interest rates will have different impacts depending on the types of assets.\u00a0\u00a0\u00a0<\/p>\n
Generally, real estate sectors that have short-term leases, such as multifamily and self-storage, can raise rents to keep up with inflation.\u00a0 If occupancy rates remain high, new rental agreements can be signed at incrementally higher rates.\u00a0 With the cost of first-time home ownership increasing with 10-year rates moving up, multifamily occupancies should remain high as prospective home buyers are squeezed out of the market.\u00a0 New construction of single-family homes has lagged demand for years, and the relative shortage of supply will keep many renters renting.\u00a0 REITs have shown increasing interest in assembling portfolios of single-family rentals, capitalizing on the shortage of affordable housing for working-class buyers, and the ability to raise rents.\u00a0 Self-storage properties have the added flexibility of month-to-month rental terms at adjustable rates. REITs have been adding portfolios of self-storage properties, recognizing the advantages of the asset class as demographic trends continue to favor suburban migration, downsizing and Americans\u2019 propensity to hang on to their \u201cstuff.\u201d\u00a0\u00a0\u00a0<\/p>\n
On the other end of the spectrum regarding owners\u2019 coping with higher inflation rates and higher interest rates, office lease expirations are going to be problematic.\u00a0 A record amount of U.S. office space is hitting the market this year, putting property owners in a bind and threatening to leave banks and other lenders stuck with more troubled loans, according to the Wall Street Journal.\u00a0 The effects of the COVID-19 pandemic, with more office workers staying home or using a hybrid approach to office work, more tenants are shrinking their office space needs. The WSJ reports that 243 million square feet of U.S. office space will have leases expiring in 2022, the most office space to become available since JLL began tracking the data in 2015.\u00a0 This represents a 40% increase since 2018.\u00a0 The office vacancy rate is up to 12.2%, up from 9.6% at the end of 2019.\u00a0 Green Street estimates that hybrid work will cause a 15% drop in office space demand.\u00a0\u00a0\u00a0<\/p>\n
According to Trepp Inc., about $1.1 trillion of loans backed by office buildings are outstanding and $320 million of those loans are maturing this year and next.\u00a0 Quoting Matthew Anderson at Trepp in the WSJ, the combination of rising interest rates, lower occupancy and a mountain of debt coming due \u201ccould be a triple whammy\u201d for building owners.\u00a0\u00a0\u00a0<\/p>\n
According to Marcus & Millichap\u2019s recent survey, investor sentiment has fully recovered from the Pandemic and is at its highest level since 2015.\u00a0 Investors\u2019 top concerns are higher interest rates and inflation.\u00a0 With the cost of capital increasing along with higher interest rates, investors are telling Marcus & Millichap that a 150 bps increase in rates would cause 46% of investors to buy less real estate, and if there is a 200-bps rise, 63% of investors would buy less property. According to the Fed\u2019s plans to raise rates seven times in 2022, that would mean a 175% rise in rates.\u00a0 Investors that are planning to add to their real estate portfolios may want to act soon, before the Fed\u2019s plans materialize in higher lending rates.\u00a0 U.S. inflation hit a 40-year high at 8.5% in March according to the Labor Department\u2019s announcement on April 12.\u00a0 There have…<\/p>\n","protected":false},"author":3464,"featured_media":159720,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"single-article.php","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[2806,3010,2843,2939,2955,2965],"tags":[],"class_list":["post-226810","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-asset-class","category-asset-manager-news","category-blue-vault","category-commercial-real-estate","category-inflation","category-performance"],"acf":[],"yoast_head":"\n
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\nSources:\u00a0 S&P Capital IQ, Marcus & Millichap, Wall Street Journal\u00a0<\/em><\/p>\n