Chicago, Illinois, August 1, 2023 – As inflation sits at a 40-year high, the Fed raised rates by a quarter point in July, reaching levels last seen in 2001. This rate hike is the 11th increase in 17 months, representing as much as 5.5%. The Fed’s decision tames inflation to the mid-three-percent range from a four-decade high of over 9% last year. Furthermore, the Fed hinted that another rate hike is possible, as the two-percent annual inflation target remains a priority. However, the side effect includes a rising number of defaults and repricing of the CRE sector, as noted by the following capital market trends:
Limited Risk Appetite: With investors witnessing attractive rising rates for shorter-term and lower-risk investments (e.g., treasuries), many will stay on the sidelines and avoid funding real estate projects not properly positioned to reflect mortgage market conditions and new higher-yield realities.
Capitalization Issues: Each rate hike cycle further pressures property owners burdened by upcoming mortgage maturities or floating-rate debt to take action. Usually, such measures include improving cash flow, if market conditions permit, or infusing more equity to compensate for higher financing costs. As a result, the overall cost of the capital stack becomes paramount, eventually leading to the repricing of such assets. For now, gone are the days of capital sources lining up to provide “cheap” financing for various realty ventures.
Defaults: Unless the Fed takes drastic actions to lower interest rates or favorable supply/demand fundamentals emerge in the CRE industry, projects not matching lender and investor pricing expectations will lead to funding problems. In particular, the office properties suffering declining demand and highly leveraged assets for all property types are the first victims succumbing to loan defaults.
The Real Estate Capital Institute’s® director, John Oharenko, believes, “Later this year, many more investors, including lenders and equity capital sources, will reprice assets and bring deals to the market based lower prices not seen in many years. Attractive buying opportunities, or painful dispositions will soon characterize the investment horizon.”