Commercial Real Estate Sector Rising

November 10, 2014

REALTORS® who work with commercial properties can expect overall conditions to show continued signs of improvement during the next few years—but commercial real estate practitioners need to keep a close eye on the Federal Reserve, which is poised to raise interest rates in 2015, NAR chief economist Lawrence Yun said Friday at the REALTORS® Conference & Expo.

Prices and rents for the commercial properties are on the rise and sales volume is increasing, driven by strong job creation in many states, mild inflation and low energy costs, Yun said. “More jobs means more demand for office spaces, more demand for warehouse spaces, more demand for rental housing, more demand for retail space. So with the economy expanding, the commercial activity should be rising” as well, he said.

These factors have helped the commercial real estate sector recover from the downturn stemming from the Great Recession, but they also are contributing to a growing sense among economists that the era of highly favorable monetary policies will soon end. This could adversely affect capitalization rates—a measure of how well a real estate investment is performing based on the ratio of net operating income to its original price.

“I am of the view the Federal Reserve will increase interest rates sooner, because rents, a major component of consumer price inflation, [are] rising strongly,” he said, predicting that the central bank could raise the benchmark Federal Funds rate as early as next April.

Mortgage rates can be expected to rise as a result of the Fed’s shift in policy, which means that for capitalization rates to rise, landlords will have to raise rents, or property prices will have to decline, Yun said. “Property owners should be not overly concerned, but they should be monitoring what will happen to prices” as the Federal Reserve reacts to improvements in economic conditions.

Another issue commercial property practitioners need to watch is the availability of credit. Financial institutions that traditionally cater to real estate investors involved in relatively small deals, such as credit unions and local banks, are reluctant to make loans because of new government regulations that govern lending, Yun said. “Community banks are feeling strangled by all the regulations coming from Washington.”

—By Sam Silverstein, REALTOR® Magazine