Rising Confidence in Expansion is a Key Factor
Federal Reserve raises its benchmark rate by 25 basis points due to a positive economic outlook. The Fed’s confidence has improved significantly over the past year given the steady retail sales growth and tightened labor market. Rising Fed Funds do not necessarily align with Treasury rate movement, thus the Fed’s action will not cause a dramatic change in the 10-year rate.
Rate Increase Causes Investors to Review Potential Impact
The jump in long-term interest rates at the end of 2016 caused buyers to recalibrate their assumptions, widening the bid/ask spread and slowing commercial real estate transactions. Investors have begun to factor the rising interest rate environment into underwriting but the uncertainty regarding tax and fiscal policies will continue to restrain sales until greater clarity emerges.
Rate Outlook for 2017
At least two more rate increases were signaled by the Fed for the remainder of 2017. Strong confidence combined with rising fiscal stimulus and tax cuts, however, could spark faster economic expansion and cause the Fed to become more aggressive with rate hikes in an effort to maintain balanced.
The Federal Reserve must focus on the delicate balance of maintaining growth without allowing inflation to rise too fast. However, rising inflation does signal stronger economic growth and boosts the appeal of commercial real estate due to its inflation-hedge characteristics.
Though yield spreads will likely compress as the cost of capital rises, cap rates have not historically moved in tandem with Treasury rates. Declining vacancy combined with rent growth will underpin continued performance gains, sustaining a positive long-term investment outlook. Combined with market liquidity and strong capital flows to commercial real estate, valuations remain supported.