The rise in US interest rates has raised speculation in the commercial real estate industry that close to four years of gains in property values may be about to come to a halt, The Wall Street Journal reports.
Low rates have been fueling the rise in property values until recently, while rents and occupancy rates have remained below peak levels. Low rates have led to increased demand for property from investors who are looking for higher yields than they could get from the bond market.
Analysts warn that higher rates will put downward pressure on prices and demand even if the recovering economy helps to give a boost to rents and occupancy rates.
Tad Phillip, the director of commercial-real-estate research at Moody’s Investors Service, said, “We think that rising rates will largely cancel out rent growth and stall out values.”
Investors in publicly-traded real-estate investment trusts have been active sellers recently. Since the stock market hit its May 21 high, the Dow Jones Equity All REIT Index has dropped by 14 per cent, compared to a 4.9 per cent decline in the Standard & Poor’s 500.
Higher rates have also taken a toll on the market for commercial mortgage-backed securities (CMBS), which is a major source of debt in the commercial property industry. Rates which are being charged to borrowers have increased more than a full percentage point, while the value of bonds has decreased in market trading.
Any mortgage rate increase could be a brief one, and current rates are still at close to historically low figures. Commercial real estate values have increased with rising rates, usually when rents and hotel rates have risen, too.
Commercial property values decreased dramatically after the 2008 global economic crisis. Values did start recovering as the economy began to stabilize. The initial improvements were limited to Class A properties in top cities before accelerating and broadening as investors looking for higher yields entered the market. Commercial property values in May were 4 per cent higher than their 2007 peak and 69 per cent higher than their lowest point, which they hit in 2009, according to a Green Street index.
Mike Kirby, the chairman of Green Street, said recently that low interest rates “have been the primary driver” for rising values. Yields on 10-Year Treasury notes were above 2.5 per cent this month, from 2.16 per cent at the beginning of June and 1.64 per cent at the start of May.
The change was sparked by investor concerns that the Federal Reserve was planning to end its $85 billion per month bond-buying programme, which would effectively drive up interest rates. Any shift in that direction would dampen the CMBS market by making it more expensive to borrow money. Before May of this year, some analysts were predicting that Wall Street would sell up to $100 billion in CMBS in 2013.
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