Interest Rate Rise May Affect RE in a Roundabout Way
When the U.S. Federal Reserve in December raised the benchmark interest rate for the first time since 2006, the commercial real estate industry yawned. The hike was just 25 basis points, leaving plenty of spread between interest rates and investment cap rates, and real estate professionals had been anticipating an increase for years. In addition, there is so much equity capital focused on U.S. property markets that many buyers are focused on getting as much money placed as possible—and adding leverage runs counter to that goal.
But it’s possible that rising interest rates could weaken property markets indirectly. World Property Journal reports that the U.S. rate hike places additional pressure on China’s capital reserves and the value of its currency the renminbi. The People’s Bank of China (PBOC) has cut interest rates six times in the past year, and with the U.S. rate increase, 10-year government bonds in China are now just 80 basis points higher that 10-year U.S. bonds. China’s foreign exchange reserves fell from USD$4 trillion in August 2014 to USD$3.4 trillion in November 2015, and capital outflows from China have increased since the PBOC’s foreign exchange reform in August.
A lot of the capital flowing out of China has been flowing into U.S. property markets, so an increase in that trend could be seen as good for our industry. However, the biggest threat to office, retail and industrial space markets would be an economic downturn. As we saw in the first half of January 2016, a weakening Chinese economy affects U.S. stock values, which drive companies’ ability to expand. When Chinese stock markets dropped 10 percent in one week, the Dow Jones industrial average lost 6 percent in response.
It’s an open question whether a continuing decline in China’s economy will reverberate in the U.S. There’s no precedent for the U.S. economy being greatly damaged by a foreign economy, and China’s financial markets are relatively isolated from the rest of the world. On the other hand, China is a huge presence in the global economy and a source of many U.S. goods, so we’re in uncharted waters.
If the Fed continues to increase interest rates, and if those hikes prevent China from restoring its economy to health, and if China’s decline spills over to the U.S. economy—well, that’s a lot of “ifs”. But one outcome could be downward pressure on demand for U.S. commercial space, which would have a bigger impact on property investment markets than a slightly higher cost of debt would.