Everyone’s talking inflation and interest rates, but what does it mean?
In June 2022, the Fed increased interest rates by 75 basis points—its largest move since 1994, and the Fed anticipates more increases later this year.
We are seeing the highest inflation since the early 1980’s. According to Ginger Chambless, Head of Research for Commercial Banking at JPMorgan Chase, “By raising rates through this year, the Fed is trying to get a handle on inflation and slowly pull some of the excess liquidity out of the economy. I think it makes sense for the Fed to take a gradual approach. This way, they can see how the economy holds up along the way, as opposed to a more drastic increase, which might cause undue panic in the markets.”
While inflation is at a 40-year high, interest rates are still below what we saw in the 2000’s at 6.5% and record highs of nearly 20% in 1980. From a historical perspective, rates are still very attractive, but hard for the new investor group that has only known the sub 4% interest rate cycle. Investors are going to have to adjust their thinking and their proformas.
An increase in interest rates obviously makes borrowing more expensive and impacts an investor’s desired return. An investor is forced to offset the higher cost of financing with a lower purchase price on real estate. This will have an impact on cap rates which we have seen compressing over the last few years. But the market is still competitive and sellers haven’t pivoted from the high demand of the last few years, knowing in part that investors want to buy real estate to hedge inflation. So, investors will be focused more on increasing rents to drive their desired returns.
As we move forward in 2022, we may not see the movement in values right away, but sellers and buyers will soon enough find themselves at a crossroad of having to understand debt market pressure of increased interest rates and what buyers can (and will) actually pay. Sellers today are still in a great position to sell. Buyers are looking at the uncertainty in stocks, crypto, NFT’s and holding cash and real estate is still considered the safer investment alternative; but we may be seeing a market peak soon. If you have questions about selling or buying in today’s market, reach out to a commercial real estate professional in your community.