How Interest Rates, Ukraine Are Affecting Real Estate

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Last week, the Federal Reserve approved an interest-rate hike for the first time since 2018, a widely anticipated move and, likely, the first of several increases this year.

The move, an effort to tamp down high inflation, comes amid a white-hot housing market, global supply-chain logjams and a war in Ukraine that’s caused myriad casualties and rattled the world economy.

Observers in residential and commercial real estate continue to predict secondary ripple effects from the broader economic picture, including the potential for a longer bout of inflation because of geopolitical conflict abroad. But the housing market is often cited as a key economic sector to be affected by a move in interest rates by the Fed.

“There’s a confluence of things that are happening that we haven’t seen in a long, long time,” said Pat Sheehy, CEO of Sunrise, Florida-based Hamilton Home Loans.

Mortgage rates, for one, have been on the rise — months ahead of last week’s first hike by the Fed this year. Sheehy said long-term interest rates are typically driven by an expected rate of inflation, and investors have decided they need more yield.

And rising mortgage rates, so far, haven’t really slowed the housing market, although they have slowed the refinance market considerably. The Mortgage Bankers Association’s forecast in October predicted purchase mortgage originations would grow 9% in 2022 and refinance originations would slow 62% from 2021.

So will the rising interest rates finally cool down the housing market? Sheehy said he thinks demand for housing from the very large millennial generation will outpace any slowdown prompted by mortgage-rate increases. Plus, he added, household incomes have grown fairly dramatically amid elevated inflation. But economists largely maintain that rising interest rates will tamp down the record-shattering month-over-month home-price appreciation seen last year. By how much remains to be seen.

For commercial real estate, ripple effects from rising interest rates are also unclear.

“There’s historically not a consistent positive or negative correlation for REITs amid short-term rate movement,” said John Worth, executive vice president for research and investor outreach at real estate investment trust trade group Nareit. “But when the 10-year Treasury rate rises, REITs typically see positive performance over a 12-month period.”

Nareit found, during periods of rising long-term interest rates between 1992 to 2021, average four-quarter returns among REITs were 16.55%, compared to 10.68% in non-rising rate periods.

“A lot of those periods where long-term rates are rising, they’re rising because we’ve got a strengthening economy,” Worth said. “Here, we have a strengthening economy but we’ve got the Fed moving interest rates to dampen concerns about inflation. I think that creates a little bit more uncertainty.”

It’s not clear whether different commercial property types will be affected differently by rising interest rates, either.

“The conventional wisdom is that, during times of inflationary pressure, it’s better to own commercial properties with the shortest lease terms — a hotel, for example, which effectively reprices every day,” Worth said.

While that may be true, REITs generally own portfolios of properties.

“The longer the lease term, the more likely it has a Consumer Price Index or inflation adjustment in it,” Worth continued. “Because they’re operating their businesses to have a diversity of leases, with a diversity of expiry dates, the longer the lease term, the higher probability it has a CPI adjustment. I don’t see a clear distinction between property sectors.”

“Specifically for multifamily, a sector that’s seen tremendous capital investment and performance in the past year or more, there may be a flurry of deal activity ahead of additional increases this year,” said Blake Lanford, managing director of multifamily finance at Bethesda, Maryland-based Walker & Dunlop Inc. “The No. 1 impact on the multifamily acquisitions and finance sector will be elective refinances. Multifamily investors will also have to deal with where overall debt rates are, although there’s so much capital in the sector now that many deals have minimal leverage.”

Joshua Scoville, senior managing director of research at ouston-based Hines Interests LP, wasn’t available by deadline for a phone interview but said in an email the industry shouldn’t fear central bank tightening.

“Central banks don’t hike rates in a vacuum, and though higher interest rates can slow the economy over the longer term, the fact that the central banks are getting more hawkish is generally indicative of a strong economic environment,” Scoville said. “Today’s economy is quite robust with low unemployment, an abundance of job openings, strong balance sheets and rising incomes. Inflation is quite elevated but indicative of equally strong demand, despite disrupted supply chains.”

The outlook becomes murkier with the Ukraine conflict, although most continue to anticipate secondary effects to real estate from broader economic issues at this time.

“For example, the supply-chain woes that’ve plagued the globe since the pandemic are likely to persist with the war, including materials for new housing,” Sheehy said.

“REITs will be impacted if there are meaningful headwinds to the U.S. economy,” Worth said. “REITs that own U.S. real estate tend to be more insulated than other public companies from war-related disruptions.”

 

Source: SFBJ

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