Commercial Investment Real Estate

NOV-DEC 2013

Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.

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Rising Interest Rates Commercial Real Estate Cap Rate vs. 10-Year Treasury Average Rate A period of falling cap rates helps elevate returns via appreciation. Rising interest rates — refecting stronger economic activity — generally exert upward pressure on cap rates, requiring an increased emphasis on income 10% growth to ofset slower appreciation and higher fnanc430 bps ing cost. However, healed and expanding credit markets, Cap Rate Long-Term Avg. 480 bps 8% strong global investor demand for U.S. real estate, and 440 bps continued recovery in property fundamentals will help 480 bps 440 bps counterbalance the magnitude of rising rates, and lend 6% 210 bps support to property values. Having already absorbed 10-Year Treasury 490 bps a signifcant increase in interest rates, further cap rate 20-Year Avg 4% changes should tie less to speculation regarding Fed policy and correlate more with measurable economic Cap Rate 10-Year Treasury Rate 2% performance. 90 92 94 96 98 00 02 04 06 08 10 12 13* Debt and equity markets should remain stable for *Through August the foreseeable future. However, the environment is not Sales $1M and above, includes apartment, retail, office, and industrial properties without risk, and near-term volatility should be expected. Source: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Te pending appointment of a new Federal Reserve chief, Analytics, Federal Reserve Board looming debt ceiling discussions, geopolitical tensions in the Middle East, and the efects of sequestration and declines in federal spending will hamper economic growth. In addition, changes in monetary policy always present a risk some securities mature. Te Federal Open Market Committee has to the economy. In this light, the Fed has demonstrated consider- issued interest rate guidance, stating that the federal funds will able dexterity, and should gradually exit qualitative easing in an remain range-bound between 0 to .25 percent at least until midorderly manner by slowly decreasing bond purchases and letting 2015, underscoring that monetary tightening would begin only afer an economic and employment recovery has been well established. Te Fed also noted that the tightening process would occur at a more gradual pace than historical precedent. Surely, higher interest rates will impact investors across the board. As f nancing costs rise, so will investors' required returns. At a minimum, Quarterly Job Growth increased f nancing costs will decay some of the Percent of Lenders Easing Standards cap rate arbitrage of buying into secondary and 2500 100% tertiary markets, or value-add and opportunistic assets. However, the stride of occupancy and lease 1250 50% growth is likely to exceed that of primary markets and core assets for the midterm outlook. Demand for all commercial real estate, sustained by the rein0 0% forcing economy, remains solid, and supply risks are negligible for most property types. As a result, performance profts and other components will con–1250 –50% siderably counteract the efect of rising interesting rates, at least for the near term. 00 01 Recession Quarterly Job Growth (thousands) –2500 02 03 04 05 06 07 *Through 2Q Source: Marcus & Millichap Research Services, Bureau of Labor Statistics, Federal Reserve Board CCIM.com Percent of Lenders Easing Standards Recession Lenders Ease Standards as Hiring Maintains Momentum 08 09 10 11 12 13* –100% William Hughes is the senior vice president and managing director of Marcus & Millichap Capital Corp., based in Irvine, Calif. Contact him at william.hughes@ marcusmillichap.com. November | December | 2013 33

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