The Stock Market and CRE

There are many facets to this issue. First is the interest rate impact on REIT stock prices, and the negative impact they have as rates rise. While rates were near zero, REITs were a good place for investors to stash funds on which they could get both a current return with reasonable safety, but also an increase in valuation as real estate generally returned to favor and profitability. For several years it was a winning place to be. Now the REIT sector has to compete with bonds for returns on a current basis and, with CRE generally fully priced, and possibly going into slight decline, there is little incentive for investors to be in REIT shares. This is likely to just remain the same or deteriorate over the next two or three years as the ten year rises over 3% and eventually possibly over 4%. For REITs, it just makes it much harder to raise new capital and to grow the portfolio.

The private REIT market will be suffering the same issues as the public REITs. C Corp CRE companies will also have issues with rising rates making it more difficult to justify new capital raises and growth to the same degree it had been running. Operating companies may find it harder from here to raise rents, and to keep operating expenses low. This is especially true for hotels where labor costs make up as much as 80% of total expenses in many cases. Occupancy has topped out in most markets and ADR is barely rising at 2%, while costs are rising faster. This spread will worsen as the labor shortages get worse as time goes on, and as more supply enters the market. It will be further worsened as immigration is tightened and the labor pool for housekeepers and other low skill workers is tightened. As CRE values decline with the rise in rates and a general lack of new opportunities for value add acquisitions, it will be harder for many C Corps to maintain sufficient growth to keep their share prices increasing.

All of this will mean the transaction business will not be as robust as it had been in 2016 and before. REITs and C Corps will have less ability to raise large amounts of new capital. The private equity investors will run out of the value add opportunities that has driven several of the acquisitions over the past few years. For private developers and owners, it is becoming harder to compete with fixed rate investments as rates rise, and as loans remain subject to better underwriting.

The offsetting good news is the economy is doing very well, and there will be no change to all of that for at least the next two years. The one real risk is the November elections. If the Democrats do get control of the House, they will likely try to impeach Trump on some phony charge. This will evolve into a constitutional crisis since the Senate will be controlled by Republicans and any impeachment will be killed in that body. However the disruption to government will be very problematic. It would also mean no hope of any control of the federal budget and that will drive rates higher. Maxine Waters will be chair of the banking committee.  It is hard to imagine a worse choice other than Elizabeth Warren. Overall, Democratic control of the House will be terrible for CRE and the economic growth overall.

During the summer we will have the report from the inspector general, and then from the Federal prosecutor that Sessions has appointed to investigate the Democratic conspiracy to stop Trump and undermine his presidency. This will be a real scandal and will consume the news. At the same time, Trump will be vindicated by the Senate report and Mueller, as there was no collusion and no obstruction. Editing a press release is not obstruction, and firing Comey will be justified as the inspector general report comes out. The follow on investigation of the Democratic effort to stop Trump, will be Watergate doubled. In short, the summer will be consumed by political scandal, and the upcoming election, and then we will see who benefits from all this. It is my view that Republicans hold the House as the economy thrives and as the Democratic scandal is revealed.  If the Republicans do win in November, the stock market will do very well and the economy will continue to grow nicely, which is good for CRE. Rates will unfortunately rise even further in this scenario, and that will mean REIT stocks and real estate stocks in general will not do so well in 2019.

As the stock market gets back on track upward in the spring and summer, that helps the wealth effect and the capital markets for non CRE operating companies and that means more capital for expansion and more people employed. That will be the good news for CRE.

The views expressed are the author’s own and not that of ALM Real Estate Media.