This article is republished with permission from REITCafe.
On Thursday, the Federal Reserve opted to not raise its benchmark interest rate, which has been near zero since late 2008. An increase has been expected for months, but as the September Federal Open Market Committee (FOMC) meeting approached, those who believed that recent economic events would cause the Fed to delay an increase proved to be correct. Financial markets made sharp gains following the announcement but ended the day down, in part because the lack of increase indicates that the Fed believes current economic growth is fragile.
A number of factors weighed against a rate hike. The economic downturn in China and turmoil in U.S. financial markets made a rate increase seem less likely. In addition, U.S. job growth in August was lower than expected and wage growth has been minimal.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2014 | End 2013 | |
| Industrial | 165 | 168 | 149 | 138.5 | 170 |
| Multifamily | 160 | 161 | 146 | 139.8 | 166.7 |
| Office | 174 | 175 | 158 | 148 | 175 |
| Retail | 164 | 166 | 150 | 139.8 | 175 |
| Average Spread | 165.75 | 167.5 | 150.6 | 141.5 | 171.7 |
| 10-year Treasury Yield** | 2.13 | 2.18 | 2.22 | 2.17 | 3.04 |
On the other hand, a number of factors supported the case for a rate hike. Job growth has been steady through much of 2015, and unemployment is down to 5.1 percent. Homebuilder sentiment gains in September further indicated that the economy has shrugged off worries about China and U.S. financial markets.
The lack of an interest rate increase was positive news for real estate and real estate investment trusts (REITs), which gained 1.10 percent for the day. Higher interest rates are viewed as bad for REITs: it is widely thought that REIT performance will suffer as borrowing becomes more expensive and that higher interest rates will cause investors to pull money out of REITs in favor of other investments. In addition, cap rates could rise and property values fall because investors are able to pay less for properties after factoring in their cost of financing.
Nevertheless, a rate increase would not necessarily have been bad news for REITs. The rate hike would have indicated that the economy is on solid footing because the Fed had noted that it would not raise rates until it saw a sustained economic recovery. In addition, current strong real estate market fundamentals that are fueling rent growth and REIT profitability would have limited the impact of higher interest rates. Some current financial-market volatility is due to uncertainty related to a rate increase, so raising rates should reduce this uncertainty, which affects REITs. Higher interest rates also could help cool off the economy and limit potential real estate market frothiness.
The focus now shifts to the Fed’s next meeting, October 27–28, and whether rates will be raised then. Whenever the Fed begins to raise its benchmark interest rate, the first increase will likely be small and will have little immediate impact on borrowers’ pocketbooks. The move will be significant because it will signal a shift in Fed policy, but, ultimately, how far and fast rates rise are more important concerns.
* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.
** - 10 yr. Treasury Yield as of 09/18/2015.
