The Long Game…. Could it be another 7-year Cycle?
The Federal Reserve’s interest rate increases have had an impact on the volume of both residential and commercial property sales during the past year. As the Fed raises rates, it affects the cost of borrowing money for commercial property investments. This has resulted in higher costs for investors and developers. Additionally, higher interest rates lead to slower economic growth, which could reduce demand for commercial real estate and cause prices to drop.
Fed actions are not the only issues negatively impacting the value of commercial properties. Rent rates have slowed or even reversed, insurance rates are having significant increases, inflation has caused maintenance and repair costs to steadily increase as well.
The long-term cycles of commercial property wealth building are also affected by Fed rate increases. When rates are low, investors may be more likely to invest in commercial properties due to their potential for appreciation over time. However, when rates rise, investors may be less likely to invest in these properties due to their increased cost of borrowing money and the potential risk associated with them.
Many property owners are holding in place and taking a wait-and-see attitude, however, this current cycle of rising interest rates will create an urgency for investors to sell their properties now before prices drop.
Let’s look back at the Great Recession for some instructive history. The economy had been slowing for several months and then the banking crises during the Fall of 2007 triggered the Great Recession which lasted well into 2009 over 18 months followed by three years of GDP growth rates below two percent (2%).
According to the St Louis Fed, commercial real estate prices peaked in Q3 2006, bottomed out in Q3 2009, rebounded in Q1 2011, followed by another drop, and then three years of treading water before stabilizing at that Q3 2006 level in Q3 2014. Our takeaway; This was over a seven-year cycle to regain values, often with significant reductions in cash flow during those years.
It is not our expectation we will see the exact same scenario in 2023 – 2025, however, the Federal Reserve seems committed to continuing its rate increases into an undetermined future, where inflation begins to show more significant reductions.
Their objective with those rate increases is to cool the labor market ( essentially throwing people out of work ), reducing demand, and economic activity, ( rental rates have already slowed in many parts of the country ) and perhaps ignite an actual recession. This combination is a formula that inevitably leads to price reductions in many segments of the commercial real estate market.
With this more complete understanding of the significant long-term impact of Fed interest rate increases on commercial real estate, investors can recognize that now, while values seem to be holding would be a good time to consolidate gains, create a cash position, and look for opportunities over the next several years.
May of our clients have begun just such a process.