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Real Estate Lending Continues to Thrive Despite Interest Rates
The Federal Reserve has announced that yet another interest rate increase is in the works, as the U.S. economy shows steady growth with 138,000 jobs added in May. While home mortgages continue to slow, lending in the commercial real estate industry is actually continuing to grow despite these changes.
Recently published data says that commercial real estate lending grew by nearly ten percent between 2016 and 2017. At more than $2 trillion, commercial loans represent 22% of all lending, almost equivalent to home mortgages.
There are several considerations to take into account when evaluating how Fed rate hikes will affect commercial real estate lending. Higher rates will cause an increase in market lending in the short term as developers and investors worrying about future hikes take out loans now to lock in rates (remember that CRE loans are generally 5 to 7 years). Looking ahead, the biggest issue may be credit. In May, loan officers at U.S. banks reported tightening their lending standards for commercial real estate loans with the Federal Reserve warning that a run-up in commercial real estate prices could amplify any future economic downturn. They cited “a less favorable or more uncertain outlook for CRE property prices, capitalization rates and vacancy rates”. The Fed is putting a bigger focus this year on commercial real estate in its annual “stress tests” of how well big banks could weather financial turmoil.
The jury is out on how profoundly interest rate hikes will affect CRE activity; however, there are reasons to be optimistic because property incomes have improved dramatically over the last several years. The strong economic growth scenario will continue to strengthen Net Operating Income, likely offsetting the discounting impact of higher interest rates.
Recent surveys show that business owners are optimistic about the economic growth that this rate increase signals, though Federal Reserve Chairwoman Janet Yellen remains cautious. She stated in March that the Fed predicts the U.S. economy will “expand at a moderate pace over the next few years.”