Interest Rates Can Provide Some Clues
With the world of private market investing made increasingly accessible to broader swaths of society, recently more people have been asking themselves: is now a good time to invest in commercial real estate?
While the answer to this question largely depend on which property types, asset classes and submarkets you’re considering, today’s low interest rate environment offers three macroeconomic cues which have a meaningful pertinence to income-generating property investments:
- Enhanced liquidity
- Low inflation
- Easier financing
Together, these three interrelated conditions suggest continued healthy demand for commercial real estate development and growth, and for investors translate to an increase in passive income from rental property leases. Let’s take a closer look at how.
1. Greater Liquidity via Lower Lending Costs Fuels Cash-intensive Investments
In a stark reversal from 2017-2018, which saw the Fed increase interest rates to their highest level since the 2008 economic crisis, the central bank spent the latter half of 2019 loosening the purse strings by lowering the interest rate by 750 basis points.
So why does this matter? In practical terms, a lower interest rate indicates that there’s a greater incentive to lend, borrow and spend capital, while higher interest rates disincentivize these same behaviors in favor of saving cash for interest-rate sensitive investments. And with interest rate changes affecting the borrowing rates between large financial institutions at the very top of the economic food chain, the lower lending costs and greater liquidity brought about by a lower interest rate has a sizable impact on the value of pretty much every capital investment, from stocks and bonds to gold and property. For cash-intensive investments like commercial real estate, low interest rates often mean greater cash flow, fewer costs and considerable yields from income-generating operations.
2. Lower Inflation Rates Benefit Income-Based Commercial Properties
According to an MIT study on real estate as an inflation hedge, for every commercial real estate property type with the exception of retail properties, property values generally fared better than property income as inflation rose. This means that during periods of high inflation, longer-term projects that rely heavily on cash flow to deliver returns are at a disadvantage. But while interest rates are relatively lower now than they were last year, historically they have trended much higher. What brought about this change, and why shouldn’t commercial real estate investors worry about interest rates climbing again in the near horizon? Well, the answer to both of those questions largely has to do with inflation—or the lack thereof. In essence, the Fed’s primary motivation for increasing interest rates and putting the brakes on borrowing is inflation—an increase in relative prices based on imbalances between supply and demand within an economy. However, despite the high level of corporate debt that has been generated over the past decade of near-zero interest rates, there has been essentially no sign of inflation when benchmarked against changes in the consumer price index, the Fed’s main gauge of inflation.
There are several theories on why inflation has been so elusive despite a decade of stable economic progress, but regardless of the underlying causes, inflation simply hasn’t materialized as of late. As a result, in spite of continuous efforts to coax a modest increase in inflation within the U.S. economy since the 2008 Recession, including another interest rate cut this year, inflation rates remain stubbornly low, to the benefit of investors who have diversified their portfolios into income-generating properties.
3. Easier Financing is a Catalyst for New Development
With interest rates stuck near historic lows, in most cases financing for commercial real estate projects has become easier to come by, and just as easy to repay. Looking back several decades, historically low vacancy rates among rental properties have helped support demand and drive price growth. The chart below shows residential vacancy rates at 30-year lows.
The sum of these forces means that commercial real estate developers can acquire easy financing at low rates for high-demand rentals, which can help generate sufficient income to quickly repay those debts. This was the case throughout 2018, which saw a record $573.9B in commercial real estate mortgage originations for multifamily properties, according to the Mortgage Bankers Association. And on the other side of the equation, commercial real estate loan delinquencies are at 30-year lows.
This is great news for investors in commercial real estate since that additional yield generally translates to a higher annual surplus after debt repayments are made. This means many investors can look forward to an increase in passive income from their property’s leases.
There’s No Perfect Time to Invest, But There are Promising Investments All the Time
In spite of concerns about what the current interest rate means for the U.S. economy as a whole, the current macroeconomic environment indicates towards continued, healthy demand for commercial real estate development and growth. Obviously, as with any time-sensitive opportunity, there’s no guarantee that the conditions favorable to your investment won’t suddenly change. Inflation could unexpectedly skyrocket and drive interest rates higher, eating into your cash flow. Similarly, housing prices could fall to the point where apartment rentals are no longer as in-demand as is the case currently.
That’s why at iintoo we take a data-driven approach to assessing the viability of every prospective deal against multiple market scenarios, working directly with project developers to create pre-approved business plans, and managing the full lifecycle of each investment. By rigorously vetting the projects we place on our platform, pursuing pockets of opportunity across America’s regional submarkets, and streamlining our members’ online investment process, we aim to provide investors with access to the commercial real estate market in a way which delivers lasting value across a broad spectrum of economic conditions.
To learn more about what iintoo can offer you, feel free to explore our platform.