Hike! The Herald Fed Sings

December 08, 2022

The trajectory of rate hikes by the Federal Reserve has had a meaningful impact on asset values this year. Historically, rising interest rates have aligned with higher risk-adjusted returns for real estate investors, with an average 12.8% annual total return of the NPI during past periods of Fed hikes. Although higher borrowing rates increase the cost of capital for property buyers, rate hikes typically coincide with a strong economy and easy credit. Economic strength can lead to mark-to-market rent growth opportunities and strong tenant demand within in-favor sectors, and open credit markets may allow investors to increase their purchasing power, thereby expanding the pool of real estate buyers.

This year, the Fed has raised rates to specifically target heightened inflation. During periods of price pressure and subsequently higher rates, property owners tend to increase rents in order to keep pace with growing maintenance and replacement costs. Owners and investors also benefit from supply-demand dislocations when construction, financing, and labor costs rise, placing downward pressure on new supply and ultimately increasing demand for rentals. Historically, rent growth in the U.S. has averaged 3.0% in a rising Fed policy environment, compared to 1.7% and 1.4% in steady and declining rate environments, respectively.¹ While the ultimate impact to real estate valuations from this period of higher inflation, rates, and economic uncertainty is still unknown, the asset class does benefit from its ability to effectively pass through costs, providing a hedge against macro headwinds.

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¹Federal Reserve, Hines Research 1990–2021Q4 for U.S. markets, CoStar, Property Market Analysis, Colliers