WASHINGTON, DC—Construction costs are rising. We know that. What we don’t know is what will happen with interest rates. So before we can answer the question posed yesterday—which is worse, rising rates or rising construction costs?—we need to nail down somewhat a timeline about when rates will start to rise before we can compare that scenario to construction costs that are rapidly becoming downright frightening. A query to the Federal Reserve Bank, we suspect, would be a waste of time. The next best option is to ask people on the ground, grappling with this issue every day as they make decisions about development, acquisition, dispositions and refinancing. So we did.
For the most part, people believe what Janet Yellen, the chair of the Fed, has been saying: later rather than sooner and less rather than more.
Kevin White, director of Acquisitions of Virtus Real Estate Capital, for example, doesn’t believe the Fed is going to raise interest rates this year, “but I do think that at least one rate hike is eminent in 2015 if the economy continues to track similar to its current trajectory,” he tells GlobeSt.com.
Ditto Dean Pappas, a partner in Goodwin’s Real Estate Capital Markets Group. He tells GlobeSt.com that he cannot imagine the Fed raising rates this year “or anytime soon.” “The markets, both real estate and stock, would almost certainly collapse with any significant increase in interest rates,” he says.
Ditto, in fact, just about everyone we queried.
Lawrence Goldstein, senior vice president at NAI Hunneman, a commercial real estate brokerage firm based in Boston notes that the Fed will almost certainly scaling back its monthly purchases of Treasuries, and for the time being that will be it main liquidity play.
“They will not raise interest rates until there is no longer the need for them to buy Treasuries, thus reducing the current stimulus to zero,” Hunneman tells GlobeSt.com. “Once this has been achieved we will see the rate increased slowly within the following six months, that rate will continue to rise as the economy grows, and not a minute sooner. This will be done so that they will not cause upward pressure on incomes, or allow the economy to “overheat” which would be the impetus for inflation.”
Peter Muoio, chief economist of Auction.com, also is in the no-interest-rate-increase-camp but for subtly different reasons.
While the US economy is gaining momentum, allowing the Fed to being normalizing its policies, the EU has continued to struggle, he points out. “This has resulted in interest rates declining throughout the EU as expectations mount that the European Central Bank will have to ease further or take additional measures to backstop peripheral debt markets and jumpstart the economy,” Muoio says.
“This phenomenon is leading to a sort of arbitrage trade with US rates, pressuring them in the face of tightening monetary policy.”
The upshot, he continues is that both trends likely to continue throughout this year, keeping rates in the mid-2% range. “Beyond this though, the economy is clearly heating up and the Fed is unwinding its policies, and raising rates cannot be far off in 2015. We expect rates will remain near their current level through this year before rising over the next 2-4 years, though not to ‘normal’ levels” where the Fed Funds is around 3.75-4%.
Stay tuned for part 3 when we look at the impact rising construction prices are having and how this increase stacks up against a still unrealized increase in interest rates.