Impact of Rising Interest Rates on Commercial Real Estate
We are seeing some interesting transitions happening right now in the market. The residential housing market has already started to feel the effects of higher interest rates. We can expect real estate prices in both the commercial and residential sectors to level off with interest rates on the rise. Some areas of commercial real estate, however, are poised to show continued strength despite changing market conditions. Multifamily and retail are among the classes that have been the strongest even as other assets fall behind.
The US is still experiencing record low unemployment rates, which will continue to drive the multifamily rental market. Additionally, due to high interest rates, those who may have been considering home ownership six months ago may now decide to continue renting for the time being. According to James Halliwell of Principal Real Estate Investors, “…as previously addressed, higher interest rates may reduce the relative number of home buyers, which will result in increased rental demand. Given the multifamily sector has shorter term leases (generally one year), it is a sector that can (in the absence of significant rent controls) frequently reprice its leases to capitalize on increased demand, resulting in higher market rates”. Multifamily will continue to be a sound investment class for in the future for these reasons. The short-term leases coupled with tenant diversification will provide a hedge against inflation. This gives owners the opportunity to offset increased expenses to tenants more frequently than with long-term office or retail leases.
Certain retail businesses have also proven to be inelastic in times of a market downturn. We can expect value retailers such as Dollar General, and Costco to out preform their more expensive competitors. Brokers and investors should be seeking STNL (single tenant net lease) assets for their stability in these market conditions, particularly those with national credit tenants.
It can be expected that the office market will continue to see slow growth. However, this will provide an influx of assets with affordable price tags. Investors oftentimes will make bullish assumptions in a strong market that will force them to liquidate during an unseen downturn. In a recent Wall Street Journal article, analysts stated that “hotels, office buildings, senior housing and industrial properties recorded big drops in sales last month. Sales of retail properties were up in April, the fourth consecutive month that U.S. households boosted spending, while apartment building sales continued to rise due to strong tenant demand and landlords’ ability to raise rents.” This period in the market cycle has historically been a great time for bargain hunters to pick up deals that were unavailable in a stronger market. Brokers and investors should continue to eye multifamily and retail assets for their strong growth, and be looking out for great deals in the office and industrial space. The sellers’ market that has been rampant for the past 18 months is now starting to cool, and high interest rates often favor the buyer, particularly those with greater liquidity.