Interest rates are among the top concerns for office investors this year. This year, interest rates are expected to increase nominally several times. The incremental changes in interest rates could have a big impact on the capital stack for investors, according to Tim Lee, VP of corporate development and legal affairs at the Olive Hill Group. The firm has been very active in Los Angeles, but is shifting its strategy this year to look outside of the California market. Although it is optimistic about the year ahead—Lee says that the fundamentals remain strong—interest rates are one of its top concerns.
“For us, interest rates are very important. Some of the key threats that we are looking at in the first half of this year is focused on interest rates,” Lee tells GlobeSt.com. “That will affect how the capital stack goes. In some instances where debt has become more expensive, we are seeing that ourselves and other investors are increasing the amount of equity that they are putting into deals and lowering the amount of debt because there is so much equity that needs to be placed. There is a backlog of equity that has been waiting on the sidelines.”
Interest rates are the firm’s chief concern, the volatility in the stock market earlier this year also raised eyebrows, as it may point to deeper economic issues. “From a macro view, we also feel that there are some systemic threats with the volatility in the stock market,” says Lee. “While we aren’t seeing a direct effect on commercial real estate, it does affect the psychology and the environment that people are in when they are considering values.”
Pricing in core markets is continuing to climb, and that will put additional pressure on investors, especially if interest rates rise. The abrupt decline of Chinese investment should have helped to bring pricing down, but Lee says that other investors have filled the gap and kept prices competitive. “It definitely looks like foreign buyers from Asia has slowed down,” he says. “That is because of the capital outflow restrictions that they have. That has caused a bit of turmoil with some larger Chinese buyers. We have noticed that Canadian buyers have stayed in the market and are still looking to place money. Additionally, some domestic buyers that have been outbid for the last two or three years are still active in the market. So, things are still bidding above expectations.”
Despite the concerns, Lee remains bullish on the office market and his outlook for office activity in 2018. “We think there is going to be a bit more volatility this year, but at the end of the year, we think the market is going to be on solid footing,” he adds. “There is so much money that has been gained in the equity markets, so there is bound to be some swings as people take profits. As we have seen from the most recent swings, there are buyers that are willing to step in and the market has recovered. We think it will be a bumpy ride, but in the end we are confident in the fundamentals. Employment is low, confidence is high and tenant demand is still strong. At least on the commercial real estate side, we think the fundamentals are good.”