Throughout 2021, the US economy saw historically low interest rates in connection with the Fed’s attempt to compete with an ongoing global pandemic. Monetary theory would support this strategy of stimulating consumer demand to keep financial markets afloat during lockdowns and extreme market volatility. Fast forwarding to 2022, the US saw record high inflation in consumer goods and services. The Fed has spent the remainder of 2022 fighting a new war against inflation by raising interest rates back to what some perceive as substantive levels. As of the date of this letter, the key benchmark WSJ prime rate sits at 7%, representing a 115% increase from the start of the year via six corresponding Fed rate hikes.
Interest rates play a vital role in real estate markets to be certain, as most buyers leverage acquisitions. While interest rates are but one lever that propels the CRE machine, it should be no surprise that credit tightening will impact real estate markets more than other industries. So, what do higher rates mean for our pipeline, portfolio, and ultimately for your investments?
For our pipeline, higher interest rates could potentially drive pricing dislocation into and throughout 2023. As interest rates and the cost of borrowing rise, the widening gap between buyer’s and seller’s pricing expectations could suppress deal flow in the market. While we do anticipate a modest slowdown, we believe the market will reach equilibrium at a time when opportunities emerge for those who remain diligent and well capitalized. We will continue to find creative ways to push these opportunities through our pipeline and manage our portfolio with conservative optimism.
For our portfolio, we’ve capitalized on opportunities to secure current loans at historically low fixed rates, which insulates our existing debt exposure through 2024 and beyond. We’re also well-positioned to hedge certain inflationary impacts since our revenue streams are driven by tenancy, diffusing inflated costs through operating expense recovery and rental rate adjustments. One particular byproduct of an increased interest rate environment is higher cap rates, which could increase holding periods for some projects. Because these are income generating/performing assets, longer hold periods simply translate to increased revenue streams coupled with further amortization of existing debt.
For your investments, we’ve pursued all current investments – and deployed capital – with deliberate business plans in place, and we do not intend to deviate from those plans to the extent we have control. There is no assumption that the Fed’s abrupt shift in monetary policy will impact those tangents which drive CRE, with the exception of near-term pricing expectations. Our experience has led us to believe minor market volatility is habitual and healthy for a competitive marketplace to exist. Most would consider volatility and investment risk to be mutually inclusive, but unlike volatility, risk is something we have tenacious control over. We look forward to meeting these current economic challenges head-on while always keeping the preservation of our investor capital top of mind. Our team is excited, educated, and well prepared to flourish in the present macroeconomic conditions, as we eagerly await 2023.