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Survey: Expected Interest Rate Increases This Year Remain Top Concern Among CRE Execs

More Than One-Third in Seyfarth Shaw Survey Expect Three Rate Increases in 2018
February 27, 2018
Federal Reserve Chairman Jerome Powell delivers the semiannual Monetary Policy report to the U.S. House of Representatives on Feb. 27.
Credit: Federal Reserve Bank

Rising interest rates remain the top concern for commercial real estate executives this year, with 80% of respondents in a sentiment survey by law firm Seyfarth Shaw expecting multiple rate increases amid clear expectations that the anticipated increases would begin to weigh on commercial property markets in 2018.

For the second straight year, an overwhelming 98% of executives surveyed by the Chicago-based firm predicted at least one increase this year, with 37% projecting three rate hikes by the Federal Reserve over the next 12 months, up from just 14% a year ago.

"As the real estate industry embraces the new Trump tax cuts, low unemployment and stock market success, industry insiders expect today’s economic factors to force the hand of the new Federal Reserve chair and, consequently, shape their 2018 investment strategies," Seyfarth Shaw attorneys Christa Dommers and Ronald Gart said in revealing this year's top concerns of property executives in the third annual Real Estate Market Sentiment Survey.

"Respondents clearly believe that multiple interest rate increases will start to have a material adverse impact on the commercial real estate market," Gart and Dommers said.

Federal Reserve Chairman Jerome Powell, in his first extensive public comments since taking over for Janet Yellen earlier this month, told a Congressional committee Tuesday that the economy is stronger than at the beginning of the year, and the central bank plans to raise rates gradually.

"My personal outlook for the economy has strengthened since December," Powell told the House Financial Services Committee under questioning Tuesday about whether the Federal Open Market Committee might boost its number of projected increases from three to four next month when the FOMC formally updates its outlook.

"After easing substantially during 2017, financial conditions in the United States have reversed some of that easing," Powell told the committee. "At this point, we do not see these developments as weighing heavily on the outlook for economic activity, the labor market and inflation. Indeed, the economic outlook remains strong."

Analysts attributed part of Tuesday's sharp decline in the Dow Jones Industrial Average to Powell's optimistic comments. Since the Tuesday market opening, the DJIA had shed nearly 1,200 points, falling more than 4.5%, including a more than 500-point decline Thursday in response to President Donald Trump's vow to impose tariffs on steel and aluminum imports.

About 63% of the 157 executives surveyed by Seyfarth Shaw believe the U.S. CRE industry can absorb an interest rate increase of between 0.5% and 1.5%. About 15% believe real estate markets can only handle an increase of up to half a percentage point, roughly equal to the number of respondents who said the industry could withstand from roughly 1.5% to 2% in increases.

The U.S. federal funds rate now stands at 1.5%. Three more hikes would take it to 2.25%.

However, a newly released CBRE survey suggests that investors aren't as concerned about rising interest rates as they are about a potential worldwide"economic shock" that could undermine occupier demand.

"Despite the possibility of escalating interest rates, the vast majority of investors intend to acquire assets in the Americas," said Brian McAuliffe, president of institutional properties in CBRE's Capital Markets group. "Risk tolerance is expected to remain unchanged but investors’ search for yield and asset diversification is pushing them toward value-add assets, secondary markets and alternatives [assets] in 2018."

The CBRE Americas Investor Intentions Survey revealed that respondents are more positive going into 2018 than last year due to several factors, including the long economic expansion, new U.S. tax cuts and favorable regulatory changes. The largest share (45%) of respondents plan to increase acquisitions in the Americas over last year, a reversal of the downward or flat trend of the prior two surveys.

In total, 88% of investors plan to either maintain or increase spending in 2018, up from 83% in 2017. Just 12% of investors plan to buy less in 2018, lower than the 17% last year, according to CBRE.

Concerns about the "end of the current growth cycle" entered the Seyfarth Shaw sentiment charts with a bullet this year, ranking number 3 on the list of the greatest concerns for the commercial property sector in 2018, behind rising interest rates and challenging supply and demand fundamentals. Concerns over the effect of banking regulations and the wall of maturing CMBS loans on the industry fell from the previous year's survey to seventh and ninth, respectively.

The Seyfarth Shaw survey results mirrors rising concerns in Real Estate Roundtable's First Quarter 2018 Sentiment Index, which revealed a noticeable decline in the score of 57 for current conditions to 51 for future conditions.

Respondents are feeling comfortable about the stability of the real estate market in 2018, but many expressed concerns about what the market may look like next year, Roundtable said, citing respondent comments such as "heading into 2019, it gets foggier."

“People are cautiously optimistic but reserved," one respondent said. "How long can the cycle run? We think the window of visibility is a lot shorter than it was. People seem to feel good about this year, but beyond that, I can't say they know how to feel.”

“It's stable, but you can see signs of slowing," said another executive. "Transaction volume is down and groups are being careful."

The Trump tax turbocharge should prime the pump for continued growth, Seyfarth Shaw survey takers agreed, with 58% believing the new Tax Cuts and Jobs Act signed into law by President Donald Trump late last year will extend the current expansion by at least one to two more years.

Private equity and institutional investors are the top primary sources of equity for respondents in 2018, with more third-party investment expected this year than in 2017. Respondents viewed private equity, which jumped from number 3 to number 1 this year, as the preferred source due to its new tax benefits and current positive economic conditions.

Nearly three-quarter of survey respondents (73%) reported that infrastructure would not be a part of their investment strategy. Some 96% of respondents, meanwhile, report they have no plans to use cryptocurrency such as Bitcoin in their deals due it its perceived volatility, lack of understanding and lack of regulation.

Further, about 43% believe the rise of ride-sharing services such as Uber and Lyft will affect their analyses of acquisition and development of commercial property, with reduced parking ratios and proximity to public transportation causing investors to re-evaluate their properties and plans.

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