Real Estate Investors Encouraged by Fed Speech

Many economic indicators can affect real estate markets – employment rates, inflation, strength of the dollar against other currencies – but nothing commands the attention of commercial real estate executives like interest rates. Recent comments by Federal Reserve chairwoman Janet Yellen and others leave some doubt about when interest rates will start to increase, or how far they’ll rise. The uncertainty doesn’t seem to bother real estate investors, though, because no one’s predicting a steep increase in rates, and because the strength of the economy can support moderate rate increases—if they come at all.

After suggesting earlier this year that interest rates will likely rise in 2015, Yellen now says that the federal funds rate is in equilibrium at about zero—which may mean no increase is necessary. Since then, other Fed officials have stated that the case for an interest rate hike will be stronger in June or September.

Two things to remember: First, the market doesn’t have to agree with the Fed’s assessment of where interest rates should be. In recent months, market interest rates have dipped while the Fed rate stayed the same, due to increased demand for U.S. Treasures by foreign capital source look for a safe haven.

Second, higher interest rates don’t automatically translate into higher cap rates on real estate investment. The spread between interest rates and cap rates can vary quite a bit depending on the strength of real estate markets, economic fundamentals and the amount of capital chasing deals.

The Fed’s outlook predicts GDP growth of 2 to 2.5 percent this year—not great by historic standards but excellent measured against the past decade or so. Yellen is not concerned about the prospect of inflation, and she’s prepared for unemployment rates to drop to even lower levels. Other encouraging economic indicators – the strong dollar, low oil prices – may be seen as transitory factors that don’t really figure into the Fed’s calculations.

This is all pretty good news for the real estate investment industry. The truth is that rising and falling interest rates can be good for some players and bad for others, depending on their investment type and exit strategy, among other factors. But strong economic indicators are generally good for everyone. The only risk of a good economy is the possibility that it may turn into a bubble economy without people recognizing it—and that’s unlikely. Investors are determined not to get caught wearing rose-colored glasses so soon after recovering from the deep recession.