We’re in “steady as she goes” territory for rate cuts—what this may mean.
It’s safe to say that when the Federal Reserve chairman talks, investors listen. Consider what happened in July 2019. About an hour after Fed Chair Jerome Powell announced lower interest rates to stimulate an economy made sluggish by a trade war between the US and China and cautious consumers, the S&P lost 15 points, and the Dow dropped 99 points. At the same time, 22 out of 28 real estate stocks saw falling prices.
Of course, the market corrected and rebounded in a big way—but the Fed followed this announcement with a 3rd lowering in October 2019. All of this brings us to 2020, and the Fed’s decision—after a 4th quarter meeting—is that low inflation will mean a “steady as she goes” course. There should be no major actions for the coming year.
What does steady mean for CRE?
Generally speaking, CRE makes excellent use of low interest rates. When the cost of borrowing money is low, investors can take advantage of the savings, and this translates into more opportunities.
The difference, though, between 2019’s lowering of interest rates and 2020’s holding steady is the level of confidence. While the Fed’s actions in 2019 were borne out of economic inconsistencies—such as unemployment rates reaching a 50-year low while business and household spending were below average—remaining steady for 2020 translates into a more predictable market and consistent capitalization rates for CRE investors.
How do interest rates impact cap rates?
The first question in most CRE investment opportunities is the end result. In other words, the “capitalization rate,” or cap rate, which is the expected return on that investment. To achieve an estimated answer, you use a formula that looks like this:
- Calculate the annual gross income of the investment property.
- Subtract the operating expenses from the annual gross income to determine the property’s net income.
- Divide the property’s net income by the current market value or purchase price.
- That answer is the cap rate.
Generally speaking, a higher interest rate means it costs an investor more to borrow money. And this, in turn, eats into expected profits from the property. Lower interest rates, on the other hand, have a more profitable return—most of the time. The cap rate should never be used as a solitary tool because other variables can play with that number, such as:
- The age and location of the property
- The market and available inventory
- The creditworthiness of the investor or tenants
Also note that this is an election year after a divisive impeachment trial, and disturbing news stories of coronavirus are causing serious concerns, including some about international trade. National and international events could have significant implications for the stock market and economy, and the Fed may feel compelled to respond.
Putting it all together
Whether the conversation is about interest rates or cap rates, at the end of the day, it’s all about finding the best CRE investment opportunity for you. Working with knowledgeable professionals, such as the team at Morris Southeast Group, can help bring all of this analysis together. In addition to knowing the local market, our team can help do the due diligence required to make your money work long term.
To learn more about what Morris Southeast Group can do for you, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.
Tags: 2020 Commercial Real Estate Outlook, cap rates, CRE Investment, Fed Cut Interest Rates
