As the Federal Reserve continues its aggressive efforts to rein in the highest inflation we’ve seen since the early 80’s, many economists are increasingly concerned about how the Fed’s rapid rates increases will impact the economy. Is a recession on the horizon, and how long could it last? As you know, raising the Federal Fund Rate increases borrowing costs which tends to slow economic growth and temper inflation. At least, that’s the Fed’s objective.
On September 22, 2022, the Fed raised interest rates by 75 basis points for the third consecutive time to a target of 3-3.25% and indicated rates could reach 4.6% in 2023. These increases will likely affect all commercial real estate sectors, but how will the hikes impact net lease real estate?
Understanding the relationship between interest rates and commercial real estate is essential. As interest rates rise, cap rates tend to follow. The impact of rising rates may not be immediate and could take time to felt. Transaction activity could slow down as buyers become less aggressive while waiting to see if more pricing corrections are ahead. As markets re-calibrate, buyer behavior will force sellers to reconcile with price expectations. Once interest and cap rates align, the market is expected to regain momentum.
Demand for net lease real estate could remain healthy as these properties offer investors a predictable and stable income stream. As noted by Mathew Mousavi of Faris Lee Investments in discussion with Globestreet.com, net lease properties are often purchased without leverage, which can help immunize these properties from a downturn in activity when interest rates are rising:
“Many net-lease transactions, particularly those under $5 Million, are purchased by all-cash investors, including 1031 Exchange buyers, private individuals (located domestically and offshore), partnerships, etc. Since these investors aren’t utilizing debt to purchase net-lease properties, they are less sensitive to interest rates. In the case of all-cash offshore capital from Asia, Europe and elsewhere, many of these investors are eager to deploy capital within the US net-lease market for preservation of capital purposes, long-term growth potential, perceived security and the low-risk profiles of the US net-lease market.” -Mathew Mousavi, Senior Managing Director of Faris Lee Investments
How the Fed’s rate hikes will impact other commercial real estate sectors is anyone’s guess. Similarly, nobody can predict whether the effects of higher rates will be short-term or more enduring. If the Fed’s actions successfully reduce inflation and the economy can sidestep a potential recession, rates will ultimately decline, and commercial real estate activity should stabilize and continue to be an attractive opportunity for investors.