9/18/2015 | By Sarah Borchersen-Keto
The Federal Reserve’s decision at its Sept. 17 meeting to keep interest rates unchanged has done little to alter the favorable long-term outlook for the United States’ commercial real estate sector, according to market observers.
Steve Rado, a principal at EY and leader of the firm’s U.S. real estate mergers and acquisitions (M&A) advisory practice, said most long-term real estate investors will continue to favor the asset class.
“Fundamentals continue to improve, yields remain relatively attractive and lease structures in certain property types offer a hedge against future inflation,” he said.
Rado said he expects the record amounts of capital flowing into the sector to continue, along with a robust M&A environment. Paul Adornato, managing director with BMO Capital Markets, agreed: “A lot of that capital is seeking a safe haven. The U.S. as a safe haven has not changed, so foreign capital will continue to flow.”
Christopher Macke, managing director of research and strategy at real estate investment firm American Realty Advisors, emphasized that investors are taking a longer-term, broader outlook.
“What matters to investors is not whether the Fed raised rates today or in December or another time, but the path of action over time,” he said. Absent a surprising uptick in economic growth, Macke added, any increase will be more symbolic than meaningful, as global economic and financial market concerns are constraining Fed action.
Macke also pointed out that the decoupling of short-term and long-term rates leading up to the Fed decision underscores that long-term rates, which matter most to commercial real estate investors, will not necessarily move higher in unison with short-term rates.
Meanwhile, Rado noted that the sentiment for real estate after the financial crisis has only grown more favorable. Larger owners and operators of commercial real estate have become more conservative in managing debt and are growing cash flows “impressively,” he said. “All of these factors will make the commercial real estate sector an attractive sector in uncertain times around the globe,” Rado added.
Adornato observed that for their part, REITs have done “a very good job” of locking in long-term fixed rate debt on their balance sheets: “From that perspective, they are very well-positioned in a rising rate environment.”
According to Adornato, even though REITs still deal with the perception of being highly sensitive to interest rate movements, “we know that in terms of their earnings power and the overall health of the REITs and commercial real estate, things are pretty positive in just about every property type for the vast majority of publicly traded REITs.”
Calvin Schnure, NAREIT’s senior vice president for research and economic analysis, pointed out that the steady gains in REIT operating performance indicate that the sector remains on solid ground.
Indeed, the NAREIT T-Tracker® reported that funds from operations of all U.S. listed equity REITs was 16.5 percent higher in the second quarter of 2015, compared with one year earlier. Net operating income rose by 12.7 percent over this same period.
“Continued gains in NOI will increase the numerator of the cap rate calculations, allowing cap rates to rise organically without any downward pressure on property valuations,” Schnure said.