Will interest rates rise?

Posted by | April 03, 2015 | Blog | No Comments

A low interest rate environment typically results in higher—and often inflated—asset values, so some markets across the country are at risk for volatility if interest rates rise.

Although there are many ways that investors can differentiate themselves, a couple things certainly stand out. First, all-cash investors (who use no debt to purchase a deal) will often be preferred over buyers who need debt because a loan requirement brings additional buy-side risk to the table. Hence, some buyers have worked to purchase properties on an all-cash basis and then apply debt to the property post-closing. Second, taking a pro-active approach prior to escrow and offering sellers a shorter closing timeframe—particularly the buyer’s due-diligence period—is a strong selling point.

We may see continued cap-rate compression if supply of good assets in prime, coastal regions stays low, as capital will spill over into secondary and tertiary product and markets because it is searching for yield. Plentiful capital, combined with limited supply will continue to flood the market and lead to a breakdown in investment discipline, meaning that many investors will be more willing to take on additional risk in exchange for lesser yields. A low-interest-rate environment typically results in higher—and often inflated—asset values, so we may see some bubbles pop in various markets across the nation if interest rates shift up substantially.

The net-lease sector will only grow in appeal, since more and more capital will be allocated into hard assets that provide for no management responsibilities. From a leasing standpoint, I believe landlords may work to structure leases in a net-lease format in order to drive higher back-end value, but it will also depend on whether a tenant is set up to handle a net-lease management structure. Moreover, a tenant may negotiate more aggressively with owners who seek a net-lease format vs. a gross-lease format, potentially leading to relatively lower rents in exchange for limited management responsibilities.

You will see increasing consolidation at the institutional level, whereby corporations are leveraging relatively cheap capital markets to purchase larger portfolios or companies with holdings of a particular asset type. Additionally, debt is plentiful and is becoming more and more aggressive, thereby opening opportunities for newer buyers to purchase commercial property. In many cases, these buyers are paying a premium and using the debt to stretch in order to buy a deal.