On September 17 the Real Estate Center joined forces with REIA for a discussion on the Impact of Rising Interest Rates on Real Estate Values. James D. Shilling, PhD and faculty member in the Department of Real Estate gave a keynote address followed by a panel discussion.
Co-Moderators:E. James Keledjian, Chairman/CEO, REIA and Principal, Pathway Senior Living, LLC
Charles Wurtzebach, Chairman, Department of Real Estate at DePaul University and the Douglas & Cynthia Crocker Endowed Director of the Real Estate Center
Panelists: James D. Shilling, Michael J. Horne Chair, Real Estate Studies, DePaul University
Samuel D. Kahan, President, Kahan Consulting Ltd.
Peter M. Vilim, Co-Chairman & Co-Founder, Waterton & Associates
Highlights of the Keynote Presentation
While the Fed punted on raising interest rates at its Federal Open Market Committee meeting in September due to market volatility, one cannot dismiss the fact that the Fed still could raise rates in December, and if not in December, then early next year.
With all of the discussion in the financial press in the past several months centering on how higher interest rates would affect the U.S. economy, Shilling focused on the effects of higher interest rates on real estate values. Below are some of the key takeaways:
* Raising rates will impact everyone. Raising rates will negatively impact those who have a credit card, car loan, and a private student loan. Higher rates will positively affect those who have money in a savings account (e.g., retirees living on fixed income). A mortgage interest rate hike will worsen housing affordability for first-time buyers. Equity prices should decline while real bond yields should rise.
* Overall, a significant monetary tightening shock should cause a decline in real estate prices as a result of a negative demand shock. As rates rise, the dollar will strengthen and net exports will decline, causing aggregate demand to decline. In turn, these contractionary effects should cause real estate values to fall as rental growth declines. The intensity of these effects may vary from property type to property type.
* In terms of the apartment market, a rapid rise in mortgage interest rates will negatively affect affordability for owner-occupied housing through higher monthly mortgage payments. As housing affordability worsens for young renters, the demand for apartments should increase. In addition, for those whose monthly income is already heavily sliced with student loans, the debt burden is only going to get worse with higher rates, which will also increase the demand for multifamily apartments.
* In terms of the office market, higher rates will have a strong negative effect on most financial firms, given that financial services perform best in a low interest rate environment. However, the good news is the so-called TAMI industries - firms in the technology, advertising, media, and internet sectors - are growing much faster than the rest of the economy, and they should help fortify the demand for office space.
* The retail sector faces the biggest challenges. Retail sales still remain below the level we saw at the peak before the last recession (adjusted for population and inflation). Higher interest rates will only make matters worse, especially for consumer durable goods and automobiles.
* In terms of the industrial sector, a contractionary monetary policy will lower equilibrium real GDP in the short run, which should cause the demand for industrial property space to weaken. However, there are some bright spots on the horizon, including the large number of retiring Baby Boomers and Millennials, who are likely to create a large impact on real estate through the lifestyles they choose in the coming years. The strongest effects will be felt in the medical facilities sectors and entertainment venues as well as infrastructure and distribution facilities.
Shilling concluded with two last points. First, as interest rates begin to rise from their record lows of the past two years, homeowners with fixed interest rates of 3.5% on their mortgages will find it less appealing to sell their home when faced with buying their next one at, say, a 5.5% or 6% rate. This so-called lock-in effect could cause housing sales to plummet dramatically, especially if rates rise sharply in the coming years. Second, there continues to be a strong capital inflows from elsewhere in the world into U.S. real estate markets. What could be better for real estate values? Normally, large capital inflows fuel booms in asset prices, not declines in asset prices, and tend to give rise to self-reinforcing return optimism.
