Much Ado About Interest Rates

July 22, 2015

It is still unclear when the Federal Reserve will begin to raise short term interest rates. Even less apparent is what impact a rise in rates will do to the markets. Looking back to the first week of January 2015, the 10-year Treasury was providing a yield of 2.05% compared to 2.32% as of today July 22nd. The near 30-basis point movement upward has had its retreats and ascents over the past 6 months, but it has not necessarily made a difference in the commercial real estate market as a whole.

Transaction levels have been high in the retail, office, industrial, multi-family and hospitality sectors as the availability of capital at historical low interest rates is fueling investors to continue pushing values higher. Rising interest rates usually drive overall values down—directly affecting investor returns and putting upward pressure on cap rates. But this hasn’t happened as of late. Even with a 30-basis point increase since January, cap rates are holding steady and in some respects falling lower. Which begs the question: would a .25% increase really have that much of an impact on the market today? The surprising answer may be no. There are still very few alternative investments in the market that provide investors necessary yields, and satisfying tax liabilities would far outweigh any minor differences in cash flow.

According to a recent CNBC article by Ron Insana addressing the likelihood of a near term hike, the strength of the dollar and falling commodity prices could potentially put a wrinkle into the Federal Reserve’s plans. Insana argues that a stronger dollar dampens inflation, putting downward pressure on GDP. If the Fed is looking at higher inflation as a barometer for raising interest rates, and that number is lower this quarter than the previous, then perhaps there is reason to stay the course and keep rates where they are. Insana also believes the rising dollar is effectively acting as a rate hike, which could further delay the rate increase.

by Michael Kaplan, COO