Business Trends

Interest Rate Concerns Remain, by CBRE

File Type: Free Content, Article
Release Date: September 2013
Average Rating:       (0 Ratings)
finance graph

Concern about interest rates and their effect on real estate returns has been front and center for U.S. investors since Federal Reserve Chairman Ben Bernanke noted in his congressional testimony earlier this year that the size of asset purchases would begin to taper off in the latter half of the year. Jon Southard, managing director of CBRE Econometric Advisors, writing in the recent issue of CBRE’s About Real Estate, said that “the concern is no secret — higher interest rates, in isolation, put downward pressure on real estate values.” But the story gets interesting when factors other than interest rates are considered.

“First, it is clear that interest rate movements and cap rate movements have a relationship that is not one-to-one,” explained Southard. “Second, growth in income is an offset to cap rate pressures that is enjoyed by real estate and separates it from bond investing.”

Southard continued that the first step in determining what might result from an increase in interest rates is to create a reasonable scenario for how much rates — particularly 10-year Treasury rates — will rise. “The surprise of the spring was just how fast rates went up once they started their increase. Is this a trend that we should expect to continue, or has there been some overreaction in the market,” asked Southard. “Disagreement over where rates are going next is of course why bond markets exist; if we actually knew the future, our focus would be on investing in bonds, not real estate. Still, there is consensus that the pace of interest rate increase over the next six months is unlikely to be as steep as it was over the last six.”

He noted that CBRE Econometric Advisors expects that there will be a period of volatility through the remainder of the year, with rates eventually resuming their upward movement — although at a slower pace than has been seen recently.

“All of this said, we are not blind to the possibility that the Federal Reserve could lose control of long-term rates and that Bernanke's recent reaction to the pace of increase could be ignored,” he explained. “A Fed Overshoot scenario has been developed because the possibility of a more substantial increase in rates is a realistic possibility. … The Fed Overshoot scenario is possible, but given the displeasure that several in the Federal Reserve — and particularly the Chairman — have expressed over the pace of Treasury increase so far, it is not likely. While it is possible for bond traders to ‘fight the Fed,’ it is difficult. This belief is also related to our economic view. While the plan for tapering has been tied explicitly to an improving unemployment picture in the second half of this year, we are not so sure that employment growth will improve much from a weakened first half. The only sense in which this would be good news is that it would reduce pressure on rates to continue to go up.”