What we’re experiencing in today’s capital markets could be enigmatic for those not well-versed in the commercial real estate (CRE) investment landscape. We are all navigating a period where unpredictable occurrences have become the norm. What was once considered normal has now evolved into a greater appreciation of the simplicities of the past – where CRE investors placed capital into core products and reaped benefits from high-performing assets in places they’ve never laid foot. As our nation fights to stabilize itself after a grueling two-and-a-half years of economic tumult brought on by the COVID-19 pandemic, our economy could not be more sensitive to rising inflation and heightened interest rates. To better understand the state of our CRE capital markets and how we can use this time to reshape an archaic industry for the better, we first must identify the significant factors that primarily influence both inflation and increased interest rates.
Inflation represents a loss in the purchasing power of money and an increase in the general price level functioning within an economy. Historically, when the economy experiences an increase in inflation levels, real estate outperforms common commodities and securities trading due to its projected long-term stabilization yields. As the dollar value decreases, real estate values increase over time due to consumer demand. Real estate offers investors a unique surety amongst other capital market alternatives. Investors understand that businesses need real estate, and humans inevitably need shelter for apparent reasons. This was the understanding before the pandemic.
Interest rates represent a percentage of the principal loaned amount borrowers are charged for a loan’s use. We often associate interest rates with how much a bank charges a mortgagee for the loan used to acquire a home or the earnings one can expect to receive from a savings account or certificate of deposit (CD). However, the status of interest rates also serves as a critical indicator of an economy’s performance. Higher rates usually cause a decrease in consumer consumption and demand, thus, reversing money flows and causing a market downtick.
The combination of increased inflation and heightened interest rates does nothing to bring confidence to the consumer market or investors. Instead, this pushes the market towards recessional patterns, whereby trade, commerce, and economic activity decline resulting in a gross stagnation of national production metrics, commonly referred to as Gross Domestic Product (GDP). During this time, household and individual income usually decrease due to a lack of employment opportunities, industrial and manufacturing production declines due to a slacking of demand, and wholesale and retail sales dramatically drop-off due to a shortage of disposable income from consumers. All of these factors play a significant role in how investors approach CRE opportunities, along with when and where capital is placed.
Multifamily housing still commands the attention of investors looking for stabilized growth even during a market downturn. The asset class has proven to be resilient along with the industrial product as more cities look to attract an educated workforce and invest in the infrastructure upgrades required to accommodate the demands of e-commerce. Alternative asset classes such as data centers, senior care facilities, and student housing are competing favorites. Still, even these opportunities seem less attractive as the cost of debt and inflation rise.
The CRE industry is far from irrelevancy. Accredited investors and the professional investment community are eager to engage opportunities that make fiscal sense. To best manage the evolution of our industry, public policy leaders must identify the impediments that discourage investor engagement and stagnate economic vitality.
For example, the Opportunity Zones legislation incorporated in the 2017 Tax Cuts and Jobs Act observed that need and has encouraged the investment of billions of dollars into primary, secondary, and tertiary markets across the nation. Due to this legislation, Chicago's INVEST South/West initiative has catalyzed over $1.2 billion in community improvement projects to reverse decades of systemic public and private disinvestment.
Leaders across the industry spectrum must continue to identify ways to keep up with the complexities of modern times to meet the needs of the contemporary world; now is the time to think differently.
This blog post originally appeared on the Project REAP website. A nonprofit program, REAP was launched in 1998 to advance diversity, equity and inclusion in the commercial real estate industry through education, mentorship and partnerships.
JC Griffin is a Vice President in Transwestern’s Midwest Capital Markets Group, where he leads private market investor sourcing, deal flow, asset valuation, transaction management and client agency functions. He is a 2020 REAP Academy alum.
SEE ALSO:
- How Borrowers Can Utilize the Debt Yield to Mitigate Risk
- Expediting Loan Closings in a Blistering CRE Market
- Optimizing Real Estate Sales Through Online Transactions
- The Financing Alternative: Sale-Leasebacks
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