The Federal Reserve raised interest rates on Wednesday, June 13, 2018 and signaled that two additional increases would occur by year’s end. Officials believe the economy to be strong enough to withstand the rise in borrowing costs without stunting the economic growth we’re experiencing. So how does this impact net lease?
The Fed has long aimed for 2 percent inflation, a rate recognized as a key level to a healthy economy. The United States economy has increased significantly from the 2008 to what professionals call a “normal” level. The most recent increases are part of a series of steps to return rates to these normal levels. Since the economy is in a good state, the Fed could soon step back and play less of a hands-on role in encouraging economic activity. Officials have stated that the US economy is strong enough to raise the inflation rate to its target 2 percent without eliminating the possibility of economic growth.
The Fed will be doing a balancing act – raising too quickly will slow down our economic growth, if not put us into a recession, whereas raising to slowly will allow inflation to get out of control. As they walk this tightrope, by the end, we expect to see rates in the range of 2.25 to 2.5% by December.
The Fed’s optimism about the state of the economy is likely to translate into higher borrowing costs for cars, home mortgages and credit cards over the next year as the central bank raises interest rates more quickly than was anticipated. But the increase in interest rates will hit consumers the most. Higher interest rates cause higher bills on credit cards, home equity lines and other kinds of borrowing. Interest rates on new fixed-rate mortgages could also climb.
An increase in interest rates affects many sectors of commercial real estate, and net lease is no exception. As interest rates rise, capitalization rates rise as well. However, there is typically a lag time between an increase of interest rates and the corresponding cap rates. This usually causes hesitation with investors to make offers as often and aggressively as they do before an increase in interest rates due to the amount of uncertainty a deal holds. And buyer’s prefer the higher cap rates as it is a reflection of their potential rate of return. Gradually, the commercial real estate sector will see a shift from a seller’s market to that of a buyer’s market. At the moment, with the paced acceleration from the Fed, the markets are in a state of equilibrium.
Although fluctuations in interest rates do determine an investor’s willingness to buy, triple net leases don’t necessarily lose their demand. Since triple net leases generate a predictable stream of income, an investor will continue to utilize this type of lease as they are not bearing the burden of the increased rates. Net lease cap rates mirror that of the US Treasury, and as a “hands off” investment, will always get you a higher return than that of the US Treasury without the risk of typical real estate investments that require more hands-on management. With net lease investments, you can count on a steady cashflow without the hassle of other investment types.