American Realty Advisors

Menu

Research Insights, February 16, 2017

Rising Rates and Commercial Real Estate: A Glass Half Full or Half Empty

The brief period following the Presidential election has been the best of times for equities and the worst of times for fixed income. The Dow Jones Industrial Average has risen more than 12% above its pre-election level, at one point increasing from 18,260 the day before the election to more than 20,620 as of mid February.  

Conversely, yields on 10-year U.S. Treasury rate increased more than 40%, at one point moving from 1.83% the day before the Presidential election to a high of 2.60% afterward.  

While these two benchmarks went in different directions subsequent to the election, both are being driven by market expectations of significantly rising rates and expectations of expansionary fiscal, regulatory, and trade policies. But is this scenario a certainty, and, if so, how should commercial real estate investors react? 

Great Expectations, Great Uncertainty

As we wrote in our research piece, “Will 1600 Pennsylvania Avenue Return to Economic Relevance, or Is It Merely Rhetoric”, a robust economic expansion is not a current certainty. There are many steps between here and the booming economy necessary to generate the earnings growth and rapidly rising rates that seem to be baked into current market pricing. First, we have little but speculation regarding the new administration’s proposed fiscal initiatives.  Second, while the President does have a majority in both chambers of Congress, he may not have many powerful allies within his own party  -- he will have to contend with a staunch group of deficit hawks who are unnerved by the  prospects of yawning deficits over the next ten years. It remains to be seen whether Congressional Republicans will wholeheartedly sign off on both a substantial increase in government spending and a reduction in taxes. 

While fiscal policy remains an uncertainty, what is becoming increasingly certain is the President’s willingness to aggressively engage the world, especially Mexico and China, in trade policy disputes. The potential impact of this stance should not be taken lightly, as it can have material implications for economic growth, trade, and inflation.  Net exports reduced 4Q16 GDP by 170 basis points. 

Absent this headwind, GDP would have grown 3.6% instead of the less than robust 1.9%.  Given the Administration’s desire for more restrictive policies the potential magnitude of trade’s near-term negative impact on GDP should give equity markets pause.  Reduced trade and falling imports would place upward pressure on inflation, and the economic implications of this are very different from inflation resulting from robust economic activity, employment, and wage growth. Rising costs of goods without commensurate increases in wages and employment impairs consumer purchasing power and places downward pressure on personal consumption, the largest component of GDP. Thus, even if the President proposes and Congress approves an increase in federal spending and tax cuts, economic growth could be somewhat offset by a combination of reduced export activity and rising costs. 

Fed Governors Face Interest Rate Governors 

Even if the market’s belief that the President will implement a expansionary fiscal policy while not following through on his aggressive trade rhetoric becomes reality, there are factors limiting future movements in interest rates.   

Download PDF

Learn more about our strategies and services

Talk to our team today to find out how ARA can provide you with the tools to help you achieve your real estate return goals.

Contact Now