Hike! The Herald Fed Sings

December 08, 2022 | Griffin Gildea, Research Associate

Line chart plots Federal Funds Effective Rate and NPI annual total return during periods of rising rates. Chart subtitle: Core real estate has historically performed well during periods when the Federal Reserve is raising rates. Chart visual description: X-axis years begin in 1977 and in two-year increments continues to 2021 with labels, though line data is through 9/30/22. Y-axis is labeled Federal Funds Effective Rate and ranges from 0 to 25%. Rate line is purple. In periods when the rate increased, 9 labels show NPI Ann. Total Return with data label and corresponding upward green arrow. Label overlay on chart shows Avg. Ann. Total Return = 12.8%. Chart data description: Peak for Fed Funds Effective Rate over time shown was 6/30/81, at 19.1%. Peak for NPI return is most recent period, with 18.2%. Chart source: NCREIF, U.S. Board of Governors of the Federal Reserve System, Moody’s Analytics, Clarion Partners Investment Research as of October 2022. End chart description. See disclosures at end of document.

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.

Print PDF > Hike! The Herald Fed Sings

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

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Griffin Gildea
Research Associate

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