Albert Franke III, Advisra

The Federal Open Market Committee (FOMC) of the Federal Reserve meets September 16^th and 17^th and may raise the federal funds target rate for the first time in nearly 7 years.  The benchmark rate has been close to zero since late 2008 in an attempt to resuscitate an anemic economy.  Some arguments for a rate increase include the need for the Federal Reserve to have arrows in the quiver to deal with a future financial crisis and to provide a “normalization” of rates to stabilize volatility in real estate and financial markets. While the FOMC has seen some improvement in the labor market, global economic growth is slowing and then there is the recent volatility in the financial markets, domestic and abroad.  China’s economic instability, Greece’s debt turmoil and tumbling oil prices all point to reasons why rates may stay where they are in the short term.  Industry experts put the odds of a rate increase this month at less than 50/50 and most agree, surprisingly, that the markets have not priced in an increase.  The FOMC will meet again in October and December.  Some analysts predict the first increase to occur in March 2016. At this point, it’s anybody’s guess when it will happen, but it’s certain to happen. 

The FOMC has telegraphed that any rate increases will be slow and gradual. The initial increase is expected to be not more than 25 basis points, perhaps followed by additional hikes over the next 12 to 18 months.  So the question is, when the FOMC raises the federal funds rate, what will be the impact on the real estate market? 

The conventional school of thought is that rising interest rates will soften pricing and hamper the real estate market.  It’s logical to assume that as money becomes more expensive to borrow, prices will be impacted.  This is particularly true when weaker economic conditions exist. The negative effect of rising rates can be offset in a robust economy with increasing consumer confidence. We are not there yet.

On the residential side, first-time buyers are probably hardest hit by a rate increase, slowing sales volume in the starter home segment. Most candidates for refinance have likely done so already, so a rate increase may be of little consequence.  That said, consumers will feel the pinch not only with mortgage rates, but also with credit cards and bank loans. In Connecticut, housing prices in most locations remain well below the 2006-2007 peak, with inventory staying on the market longer. This is during a period where 30-year, fixed mortgage interest rates are hovering around 4% and adjustable rates are in the low 3% range.  Any rate increase can’t bode well for sales volume or prices.

Federal Reserve chairwoman, Janet Yellen, has openly expressed concern about rapidly increasing asset prices, specifically calling out commercial real estate.  The availability of cheap money and unattractive returns from traditionally alternative investments have been driving prices up. This is evidenced in certain sectors by going-in cap rates being at some of the lowest levels recorded.  The descriptor “bubble” is being bandied about again and that term usually evokes positive thoughts only when it precedes the word “gum.”  Another phrase currently in vogue is an asset’s “true value,” implying an “untrue value” and signaling a lack of confidence in the fundamentals underlying current valuations.  A rate increase will impact commercial borrowers and those seeking to refinance, and would drain some air from the bubble.  It may also return some stability, investor confidence and sense of normalcy to some market sectors.  We’ll see. 

Albert Franke III, SRA, MRICS, is president of Advisra, New Haven, Conn.