Chicago, Illinois, January 2, 2017 – Mortgage rates shifted upward for the nine consecutive weeks.   The real estate capital markets welcome the new year, anticipating additional rate hike throughout the year.  Last month’s 25 basis point rate hike allowed the Fed dampen an improving economy backed by steady employment growth.  This rate hike was the only one of the year and second this decade.  Furthermore, the Fed published economic projections revealing their desire to hike rates three more times in this new year.  Today’s rate hike expectations have the following impact on capital markets:

Mortgage Rates:  Think “4%-handle” on any type of long-term debt, even at lower leverage.  Current rates are at levels similar to the first quarter of 2014.  From a historical perspective, rates are within their lowest levels of the past decade.  And spreads continue holding steady (or slightly declining) depending upon individual lender appetite.  Most lenders have reasonably robust funding objectives for this year, so pressure for tighter spreads continues, especially for lower leverage and higher-quality CRE financing opportunities.

Valuations:  A delicate balancing act of paying more for debt, but potentially trading up for higher cash flow due to inflation keeps real estate prices near peak levels.  Demand for credit-tenant, net-lease properties via 1031 exchanges, as well as a limited supply of quality CRE assets assures low capitalization rates within the current market cycle.  Alternatively, attractive purchase opportunities will emerge for those properties requiring repositioning based upon fresh capital reflecting higher rates than seen over the past few years.

Equity Risk:   Investors hope that Fed policies extend the currently favorable economic cycle as long as reasonably possible, perhaps a couple more years.  Recent business cycles (e.g., The Great Recession) created overheated conditions with punishing results afterwards.  In the current cycle, slightly higher interest rates dampen asset overvaluations.  Also, recent financial regulatory pressures discourage lenders from allowing too much leverage for riskier investments.  More so than ever, investors need greater amounts of equity capital to backstop risk, leading to more cautious deal-making.

Ms. Jeanne Peck of the Real Estate Capital Institute®, predicts “Realty capital market fluctuations bring attractive investment opportunities to well-capitalized and patient buyers.  Motivated sellers will accept lower prices, especially on deals that have been ‘retraded’ because of rising rates.”