There has been much discussion among trade and news editors about rising interest rates and their effect on a number of industries. However, when it comes to the commercial real estate and construction industry, there could be a greater disruptor—tariffs. In fact, recently hiked tariffs may play a larger role in market performance over the next year.
Incremental Interest Rate Hikes
Let’s start with interest rates. On June 13, the Federal Reserve raised its benchmark short-term interest rate a quarter percent to 2.0 percent after a quarter-percent hike on March 21. All indications now point toward two additional incremental hikes before the end of 2018. The thought among several economists is that these rate hikes will not negatively impact the market in a significant way. History demonstrates that incremental rate hikes actually act to stabilize the market, unlike rapid interest rate hikes that, over time, can increase capitalization rates, thus lowering property valuations. That, in turn, would lead to a buyer’s market.
The recent marginal rate increases should not have an overly negative impact on the real estate and construction market. Yes, these increases may likely discourage some development; but many developers anticipated them and have secured financing while locking in lower rates for longer terms than they may have sought in previous years.
Analyzing the Impact of Tariffs
As mentioned earlier, tariffs could actually have a bigger impact than interest rates. Metal tariffs imposed by the Trump administration could have a considerable impact on the real estate and construction industry. Headlines often have focused on how these tariffs will impact the country’s manufacturing and auto industries; but what about real estate and construction? As it turns out, the 25 percent tariff placed on imported steel and the 10 percent tariff placed on aluminum could impact the capital market side of the real estate and construction market. For years, foreign investment dollars have found their way into the U.S. commercial real estate and construction market; but with a potential trade war looming, foreign sources of capital could be greatly diminished.
In addition, tariffs likely would lead to more expensive construction materials which could cause projects that are close to pricing out already at a minimum required return to be shelved or abandoned altogether. The purpose of steel tariffs are to make imported steel more expensive and drive buyers to domestic producers. Yet, given the current limited quantities of domestic steel, the law of supply and demand ultimately will have a similar impact, making many development projects too costly.
Overall, the rise in interest rates will impact real estate and construction deals, but probably not as quickly or negatively as many may think. Beware, though—tariffs could have more of a negative impact on the market if they remain in place as currently proposed.
For more informatoin on tariffs and the real estate industry, please contact your CPA adviser.