How Will Rising Rates Really Affect the Market?

LOS ANGELES—The Fed's recent decision not to raise interest rates was a relief for many in the market, while others thought that a raise in rates was necessary. However, according to Chris Macke, managing director of research and strategy at American Realty Advisors, if and when the Fed does raise rates, it will have a nominal impact on the real estate market. To find out more about how the Fed's decision will affect the market, we sat down with Macke for an exclusive interview. Here, he explains why the first rate hike isn't nearly as important as the events that follow.

GlobeSt.com: Generally, what is your opinion about the Fed's decision not to raise interest rates?

Chris Macke: The first Fed rate hike is like the first step in the presidential primary process, the Iowa caucus, it is entertaining and garners a lot of attention but is of lesser importance than the final outcome - where short-term rates stabilize trumps when the first rate hike occurs. 

The path of Fed policy after the first rate hike is far more important than the timing of the first rate hike. Fed action will be tempered by foreign central bank monetary policies likely moving in the opposite direction of Fed policy; global growth concerns, especially in China; and financial market volatility. Janet Yellen said as much in her last news conference when she reiterated the Fed's position that even after the first rate hike, Fed policy will likely remain highly accommodative for an extended period of time.

 Most importantly, it is long-term rates that matter to CRE, but investors are fixating on short-term rates because they incorrectly believe long-term rates will automatically follow suit on a 1:1 basis - that is not the case when there is a significant divergence in the economic paths and central bank policy of the US and the other major economies such as China and the Euro Area.

GlobeSt.com: There was a lot of talk before this decision about how an increase in interest rates will affect cap rates in Los Angeles. Now, how does the decision not to raise rates affect cap rates? Will they be compressed even more?

Macke: If investors interpret Fed inaction as a sign of significant Fed concerns regarding global economic growth and financial market stability it may drive more capital to CRE as investors increasingly seek out the relative stability of CRE placing downward pressure on cap rates.

Whether short-term rates increase 25 basis points is of lesser importance than investor sentiment toward risk.  As long as investors continue to value the relative stability of CRE and there is not a shock that suddenly and significantly shifts investor sentiment toward extreme risk aversion, investors will continue to seek out CRE for its higher income yields and relative stability.  A gradual rise in rates has less potential to significantly move cap rates than a sudden and significant negative shift in investor sentiment.

GlobeSt.com: Without a raise in interest rates, does this start to feel like another bubble?

Macke: In divining whether or not we are in a bubble, investors would gain the most insight by assessing the sustainability of the factors currently driving capital flows to CRE, including today's low yield environment, CRE returns relative to equity returns and volatility, and CRE property fundamentals.  

GlobeSt.com: Do you think the Fed will raise interest rates before the end of the year? What is your prediction?

Macke: Whether the Fed raises rates before the end of the year they will continue to be constrained by foreign central bank monetary policy moving in the opposite direction, global growth concerns, especially in China, and financial market volatility, and as a result Fed policy will likely be more symbolic than substantial. 

Rather than speculating on the timing of the Fed's first rate hike, investors would gain greater insight into the future direction of cap rates by looking at the sustainability of the factors currently driving capital flows to CRE including today's low yield environment, equity market returns and volatility, and CRE property fundamentals.