If you accept the proposition that our economy is adding roughly 200,000 jobs per month (notwithstanding some bumps along the way and a wayward latest report), and you further acknowledge that the economy is (finally) growing at a pace of 3%, then you might agree it’s about time to gradually raise our interest rates. And for those who would say that we need wage growth and not just job growth, I would say that there is just not enough slack in the economy to justify zero interest rates (“slack” is a term that refers to the unused portion of production in the economy). And the fact that the big blockbuster news of 2014 is how low interests have dropped informs me that a small, purposeful hike might even keep inflation in line.
So what kind of rate increase can we expect? Surely a gradual one. The key to any move is its magnitude, and the Fed has no desire to raise rates sharply and cause jitters to the markets. This is especially true now, when places like Japan or all of Europe are easing. Any sharp rate raise would buoy the dollar but probably hurt US exports.
So the central question at hand is what will rising rates do to a real estate portfolio? Well, can you grow your cash flows by more than your cost of capital? If you own certain types of product, such as multi-family or hotels, or really any other product where the rent or amount you charge is constantly subject to change, then rising rates invite the opportunity to charge more! And assets usually sell based on cap rates. And there isn’t necessarily a nexus between cap rates and interest rates though some people think so (you will hear that rising rates erode property values); however, I personally think higher rates are sometimes a reflection that the economy is stronger, and property prices sometimes (or at least should) increase as a result. Like the old adage that some inflation is a good thing in that it shows the economy is actually growing (with jobs, wages). And when the economy is growing, net operating income generation occurs, even if interest rates increase.
Now, in my view, during rise rate times, inflation protected assets like multi-family/apartments or industrial should do better. Why? because of leases! Rental has to be renegotiated when a lease is up for renewal. A shorter-term lease catches up or keeps pace better than longer-term. Plus the pass through component allows owners to pass expenses on to tenants.
And when you can find opportunistic or value-add properties in these spaces, ripe for repositioning or capable of being bought on the cheap for an exigent circumstance (maybe the area is going through a Renaissance), then I think they will do especially well in a rising rate environment. Largely, today, opportunistic means owning in a place without oversupply.