The Azucena Take: Preparing for a Hawkish Federal Reserve
It finally happened, the Federal Reserve announced that they will raise interest rates by 50 basis points (BSP). This raises the Federal Funds Rate to 0.75%, which is still low. The Feds also began the process of moving towards a quantitative tightening (QT)* policy, allowing for mortgage back securities to burn off their balance sheet. The overall goal is to bring inflation, which is at 8.6% (the highest in 40 years), under control.
So how does adopting a hawkish policy help bring inflation under control? The idea is that by raising interest rates, borrowing is reduced and spending will slow down. This should result in skringing demand and causing prices to fall. However, this is not going to be a foolproof plan as there are also other factors at play contributing to the inflation problem.
What are These Other Factors?
The hit to supply chains is still a major factor in the ongoing inflation problem. Everything came to a halt when the pandemic hit but the supply chains failed to prepare for the economic boom that happened in 2021. While the supply chains have somewhat recovered, new challenges such as a wave of lockdowns in China and the war in Ukraine continue to disrupt the market.
Less talked about are the underlying inflation drivers. Wages have gone up and savings are at an all-time high. However, the price of fuel and raw materials has jumped due to demand. All this has added fuel to the overall inflation.
Finally, there is the fact that there is a lot of cash in circulation. In the United States; there are over $18 trillion in saving accounts and household cash has surpassed household debt for the first time since 1991.
What it Means for Investors?
What does this mean for the investment real estate market? Commercial real estate has been one of the safest investments during times of high inflation and thus there is going to be a lot more competition in the coming months. However, it's not an invincible shield as other factors due come into play regarding how each property holds up. Here is a quick breakdown:
Multi-tenant retail is less at risk so long as they have a long-term lease with an inflation escalator.
Single-tenant retail is somewhat at risk due to the lack of an inflation escalator and being dependent on credit.
Senior housing is less at risk since government funding will adjust to inflation while also leasing is based on market rates.
Multifamily properties are the least risky investments due to having a year-to-year lease with an inflation escalator.
Storage is the least risky as the lease is month to month and it could easily be changed.
Hotels have the lowest risk factor as they can change their rates on a daily basis.
The overall takeaway should be that investors should look right now look to properties that are resistant to inflation. At the same time, they should also plan for rising interest rates and try to lock in long-term debt as soon as possible. It also helps to speak to market advisors to better strengthen your holdings.
Keywords
*Quantitative Easing (QE) is a monetary policy in which the central bank purchases long term-securities from the open market. This increases the money supply to encourage investing.
The Azucena Take provides an inside look into the investment real estate market using the research done and data collected by Marcus & Millichap