Inflation, interest rates and now a banking crisis. There is little industry consensus about how this critical period in banking will impact the commercial real estate sector, but it has added an additional layer of uncertainty for real estate investors that were already navigating a choppy market.

William McCarthy, CRE, global chair of The Counselors of Real Estate, said that the event will likely affect interest rates and regional capital availability in the near-term, but notes it is still too soon to tell if this was an isolated event or an indicator of widespread instability.

Battling Uncertainty

While the real impact of the banking crisis is yet to be determined, it has exacerbated the uncertainty already permeating the market. As a consequence, investments and development activity have stalled and the capital sector has locked up.

“We are in very uncertain times,” said McCarthy, president of W.P.J. McCarthy and Company Ltd., a commercial real estate development firm in Burnaby, British Columbia, Canada. “Real estate always needs a degree of stability. It has been increasingly difficult to get a grip on what is unfolding because things are happening so quickly. We remain in uncharted waters.”

William McCarthy, CRE, global chair of The Counselors of Real Estate

So far, the banking crisis has triggered a series of questions. McCarthy said that his colleagues are asking if the system is damaged in a way akin to the Global Financial Crisis of 2008. Stakeholders are assessing both macro and micro implications. “We have to look at this case-by-case,” adds McCarthy. “Commercial real estate is multi-disciplined and multi-sector, and you have to look at this in context.”

Watching Interest Rates

Currently, all eyes are on the capital sector. In particular, commercial real estate stakeholders are closely watching how the banking event will affect the Fed’s monetary policy. In March, the Fed increased interest rates by 25 basis points, matching the rate increase from February.

Although some anticipated the banking crisis would trigger a change in monetary policy, the Fed seems steadfast in its strategy to reduce inflation. “All central banks have made inflation fighting their mantra. If inflation is the key, the only way to get the rate down is to control the monetary supply,” says McCarthy.

Many stakeholders hoped that 2023 would bring an end to market uncertainty, but McCarthy says that the unknown interest rate environment is keeping investors on the sidelines. If investors expect rates to drop, they will wait to make any decisions.

“Interest rates control so much of all aspects of real estate activity.  A project, and ultimately your rate of return is reflective of then-current interest rates and borrowing conditions,” says McCarthy. “The former low rates gave developers a lot of leeway with their proformas, but with higher interest rates and more stringent borrowing and lending conditions, there are currently not the same benefits available, and more risk to address.”

For the Counselors’ part, the organization is collecting data and analytics to determine the impact and advise members on risk management. “We need time and perspective,” says McCarthy. “This is a movie that we haven’t seen before, so we all have to be very careful in our thinking and actions.”