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Real Estate Investments and Rising Interest Rates

Real estate investor concerns about rising interest rates may be overblown, with the likely increase to be much less than the consensus of economic forecasters and well below pre-2008 levels, according to the latest research from global property advisor CBRE.

Since the Great Financial Crisis (GFC), long-term interest rates have fallen to very low levels and commercial real estate has been in high demand from investors. Capitalization rates (yields) have fallen substantially driving a substantial across-the-board increase in property prices. Since 2009, global commercial real estate prices have risen by 85%.

This fall in interest rates has been widely attributed to quantitative easing (QE) programs. With the global economy now in full recovery, interest rates are on a path to normalization and some real estate investors are concerned that interest rates will revert to pre-GFC levels and cause asset prices to fall.

New analysis by CBRE suggests that real U.S. long-term interest rates will increase to only 0.9% in 10 years, much less than the consensus forecast of 1.6% or the pre-GFC average of 2.4%. With inflation stable at 2%, this equates to a 2.9% yield on 10-year U.S. Treasury bills—no change from the current rate. CBRE forecasts for nominal long-term interest rates effectively put a ceiling on the cyclical highs for short-term policy rates. This still implies higher policy rates than today, but well below pre-GFC levels

“It is unlikely that the rise in interest rates will be anywhere near as sharp as some economists predict. Interest rates were falling long before the GFC, due to global demographic factors, and these powerful forces remain in play, limiting the extent to which central banks or politicians can hike rates. This is good news for real estate,” said Dr. Richard Barkham, Global Chief Economist, CBRE.”

“As a consequence, institutional investors, who are loaded up on bonds, may struggle to meet retirement-income requirements in a period of sustained low real interest rates. As is now widely recognized, real estate is part of the solution,” added Dr. Barkham.

While the predicted rise in real long-term interest rates might put some upward pressure on property cap rates over the next 10 years, the potential impact is small—particularly if growth continues—because the spread between cap rates and real interest rates will fall to pre-GFC levels. Put another way, CBRE expects the long-term structural compression of spreads to accommodate the mild increase in interest rates.

“The years of high returns from rapid cap rate compression may have passed, but a period of heavy cap rate decompression is unlikely. Cap rates will continue to respond to rent-growth expectations and other factors; it is unlikely that the cycle in cap rates will ever disappear. However, there are good reasons to believe that there has been a structural shift downwards in cap rates that is not going away in the foreseeable future,” said Dr. Barkham.

Contact FacilitiesNet Editorial Staff »   posted on: 9/19/2018

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