The CRE Response: Interest Rates Hikes and Inflation

The Federal Reserve’s Sept. 21 Effective Federal Funds Rate (EFFR) hike surprised no one. Fed chairman Jerome Powell is upfront in that fighting inflation is the prime goal.

“Our expectation has been we would begin to see inflation come down, largely because of supply side healing,” he said in a Sept. 21 press conference following the 75-point rate hike. “We haven’t. We have seen some supply side healing but inflation has not really come down.”

Speaking of inflation, many consider real estate investments as an ideal hedge. But experts discussing the current situation with Connect CRE pointed out that this consideration depends on asset type, class and even geographic location.

What’s Working

For example, most of the experts pointed out that the multifamily sector continues robust at this juncture. “The market has been very strong, and rents have kept up with inflation in many markets, even at the elevated levels of current inflation,” said Jon Siegel, Partner and Chief Investment Officer with RailField Partners.

Point Acquisitions’ President Jesse Shemesh agreed. Higher mortgage rates and continued home price expansion means more potential homebuyers are becoming renters by necessity. “This should bolster both collections and rents, and thus will remain a relatively strong sector,” Shemesh said. CWCapital Asset Management Managing Director Alex Killick also noted that hospitality, as well as multifamily, are asset types that can reset rents quickly to meet rising costs.

Also in good shape? Industrial. Furthermore, Shemesh added that an emerging subset in the broader asset class – industrial outdoor storage/industrial service facilities – is catching the eye of investors. “Even as 3PL slows down,” he said. “this subset will remain resistant and continue to operate well during these times, given the lack of supply overall and oversized demand from tenant/users.”

What Could Use Help

“Office” was the main response to the question of “what sector is getting hammered in the current environment?” But Cliff Booth, Westmount Realty Capital’s Founder and Chairman, explained that commercial real estate assets relying on aggressive loan-to-value with floating-rate loans are also likely to struggle. “This cuts across all sectors,” he noted.

Also problematic? Assets with large payrolls. For example, “we’ve seen assisted living struggle operationally, which has resulted in some loan defaults, especially at the higher acuity end of the spectrum of care,” Killick said. While hospitality properties can cut back on services like housekeeping, “assisted living can’t cut staff, as this would jeopardize residential care,” Killick added.

None of this discounts the struggles of the office sector, however. “It’s undergoing a challenging transition to return to pre-pandemic levels,” Shemesh observed. With rising costs and occupiers reassessing their needs, “look for tenants to shrink their office space or move completely to remote,” Shemesh predicted.

Added Siegel: “It’s hard to get financing on an office property now, given the change in working patterns from COVID, and the potential long-term impact on cash flow and valuations.”

Brushing Off the Crystal Ball

Siegel said the last three months of the year will represent an investment sales market reset, despite ongoing positive fundamentals. The challenges are financing uncertainty and bid-ask spreads, “Rising interest rates have put pressure on pricing, and most sellers are still reluctant to accept those changes,” Siegel said.

“More deals will be forced to reprice, or they will die,” Shemesh added. “This shift in trend will eventually turn this into a buyers’ market.”

Reaching out further, Killick pointed out that more than $10 billion of CMBS office loans will mature in 2023 and 2024. As a result, “we expect to see many assets struggle to refinance at maturity, as mortgage rates will increase from maturing loans in the 4% range to potentially the mid-to-upper 6% range,” he said.

Liquidity restraints and more EFFR hikes aside, there’s also an important election coming up. “The midterm elections can’t be ignored,” Booth said. “The party that controls Congress will have a hand in how the federal government influences inflation, going forward.”