In its efforts to curb rising inflation, the Federal Reserve on Sept. 21 raised its benchmark interest rate by three-quarters of a percentage point. The Fed also said that it plans to boost this rate in the future to fight inflation.
The Fed also said it will continue to enact hikes until its benchmark rate hits 4.6% in 2023.
This move, of course, sent another ripple of concern through the commercial real estate industry, with CRE professionals wondering how many commercial deals the higher interest rates might scuttle.
We spoke to commercial Hal Collett, chief operating officer for agency lending with the Minneapolis office of Colliers Mortgage, about the Fed’s move and what it might mean for the velocity of financing requests. The consensus? Expect a slowdown in activity as investors determine how best to operate in an environment of higher interest rates.
The big question is an obvious one: What impact will the Fed’s latest interest-rate hike have on the demand for commercial financing?
Hal Collett: The rate hike does make things more complicated. There are a lot of factors to consider. You have the rate environment and the Fed trying to catch up and curb inflation. The Fed was probably slow to react and is now trying to catch up, yet we are probably heading toward a recession now anyway. Then you have the general volatility in the economy. You have low cap rates and tremendous rent growth in the multifamily sector. The volatility with interest rates just adds more uncertainty to the commercial real estate market. Add in the geo-political risks and an election year, and you might see people put their pencils down for a while as they adjust.
At the same time, construction costs are rising. Does this increase the chances of a slow down in investment and development activity?
Collett: I think so. The rising construction costs and the delays in getting materials are contributing factors in slowing down development activity. People are more cautious about what they are going to do. Now the rate environment is increasing the cost of capital. That just adds more hurdles to getting deals done.
We’ve had several volatile years in a row when you factor in the impact of COVID. How is this long-term stressful period impacting the market?
Collett: That’s interesting. We have never been through a global pandemic. How do you react to that? What impact does that have on the business decisions people make? When the pandemic started, we thought it would be catastrophic to the lending space. It turned out to be the opposite. We had a strong 2020 and an even stronger 2021. But I think we are starting to really feel the financial effects of the pandemic now, cost issues, supply issues, so much other uncertainty that you can put into the same bucket. We have seen those things occur before, but we have never seen them occur after you’ve been through a global pandemic. I think that we are just starting to feel the financial impacts of the pandemic now.
The worst healthcare impacts of the pandemic are hopefully behind us. But the economic impact is just starting to be felt.
Even with this all this uncertainty, is commercial real estate still a solid investment when compared to other investment vehicles?
Collett: We spend a lot of time in the multifamily space. Multifamily has remained a solid investment. It’s getting more difficult for people to afford to buy a house. Multifamily, then, becomes more attractive. There is a bit of a recession-proof aspect to multifamily. Owners can raise or lower rents and remain competitive. It’s not completely recession-proof, but generally speaking, multifamily is a wise bet. In some ways, you have a natural arbitrage against what is going on in the economy. Multifamily, self-storage and industrial are all good investment options today. They are more resilient than office and retail right now. Throughout recessions or down cycles, people find opportunities to execute business, just not at the same volumes as they might have in the past.
Are you surprised that multifamily has remained such a strong investment during these tumultuous times?
Collett: I’m not really surprised. We have had an unprecedented run here. It’s been going on more than 14 years. There is a massive problem in this country when it comes to the lack of affordable housing. People need a place to live. The single-family-housing markets have been on an unprecedented run of price appreciation. That is playing a large factor in the strength of the multifamily market.
A lot of folks are renting longer than they would have before. Houses are not affordable. They have several other loans they must pay off. The rental market will hit some bumps. But demand for multifamily housing will remain strong.
Is there still more demand for multifamily housing than there is supply in most markets across the country?
Collett: The demand in a lot of markets is not diminished in any way, shape or form. There is still a gap between demand and supply.
What type of financing requests are you mostly seeing today?
Collett: A couple of years ago, there was an opportunity to refinance a bunch of deals because we were in an all-time-low interest-rate environment. There are still some refinance opportunities for people, but most of our financing requests today are for acquisitions. More buyers are out there buying deals. A lot of buyers are flooding to multifamily and real estate in general. I’d say the mix today is closer to 60/40 of acquisition deals to refinance deals. Two to three years ago, it was 70/30 the other way.
Are investors looking to buy in Midwest markets today?
Collett: The Midwest markets are our sweet spot today. We play better in the secondary or tertiary markets. Those markets tend to be more resilient, in my opinion. We find opportunities in those markets to be fruitful. The bigger markets are covered effectively by larger players, institutional players. We find better opportunities in the secondary and tertiary markets. Those markets are continuing to grow. We have seen tremendous growth, for instance, in Nashville.
When you consider financing requests, what factors do you look at?
Collett: We look at transactions in three ways. First, we look at the strength of the borrower. That is pretty consistent across the industry. Do they have experience in the market? Do they have the financial wherewithal and liquidity?
We also look at the market. We want to understand what is going on in the market or in the submarket in some cases.
The last piece is the unique piece that each lender looks at differently. Where do we have exposure? Where do we want more exposure? Is this a new client that we want to do more business with? This is about where we want to grow. We want more exposure from a footprint perspective in some markets. Other lenders might want less exposure in those markets. It’s more about lenders making their own decisions about their own book.
Back to interest rates, do people understand that today’s rates, though higher, are still at historically low levels?
Collett: I feel like that is driven more by the number of years people have been in the industry. The anomaly with rate is the last 10 years. Being at 2% or 3% is the uncommon factor. If you have been through cycles before, you realize this. If you have been in the market for four or five years, you know nothing different than this low interest-rate environment. This feels different to them. They don’t understand the anomaly.