Interest Rates and Inflation: What to Expect in 2022?

As we ended the 1^st quarter of 2022 and quarter reports are being published, I found that Albuquerque is positioned very well to withstand the Federal Reserve’s recent 50 basis points rate increase. 

While interest rates are not likely to come down soon, they are still at historic lows.  Federal Reserve Chairman Jerome Powell has apparently ruled out more aggressive rate hikes in the future announcing that “anything higher than 50 basis points is not something we are actively considering.  I think we have a good chance to have a soft or softish landing, or outcome if you will.”  Despite the increase, the expected trajectory is still below historical levels, according to Marcus & Millichap researchers.  While the Feds rate has hovered around zero for more than a decade, the planned Fed hikes will still keep interest rates at relative historic lows. It may have an impact on a market that has seen cap rates compress and construction costs rise, due to low interest rate environment.  However, history demonstrates it is possible to have a strong commercial real estate market in a higher rate environment than many currently contemplate making assumable debt incredibly valuable and accretive to the future buyers.  Additionally, more business has gone to debt funds but also banks and life companies.  Life companies have been particularly aggressive especially for the modest leveraged, longer-term fixed rate financing, institutional products. 

Inflation means different things to developers, investors and tenants.  Hard assets such as commercial real estate tend to retain their values during periods of high inflation.  Inflation shows little sign of peaking as some economists had thought would happen by this time.  What impact will this have on Commercial Real Estate (CRE) assets and investment behavior?  Well, some assets are better able to withstand price increases than others.  Investors should be able to benefit while developers are facing persistent pricing challenges for materials and labor.  Commercial real estate tends to appreciate in value proportional to inflation, writes PBMares an accounting and consulting firm.  “Inflation as a response to strong economic growth is a good thing when it comes to CRE; inflation because of persistent unemployment and stagnant demand is not. In the current environment, inflation as it stands will be good for CRE, to what level depends upon the property type and stakeholder. Tenants who are able to lock in a long-term lease with guaranteed low rent increases will see a similar benefit as owners of existing developed properties. The positive effect of inflation on commercial real estate tends to show up as increases in market rents and what tenants are able to pay.  The negative effects will most often show up in operating expenses, not to mention the overall erosion of the purchasing power of the income stream being received by the owner as inflation erodes the value of the dollar.  According to Chad Kurz, EVP at Matthews Real Estate Investments, “during normal inflationary periods, commercial real estate is impacted the same as any other industry with higher costs typically being passed down to the next consumer.  What we do know is the point of the Federal Reserve raising rates is to lower demand which will impact pricing.  If inflation and interest rates continue to increase for the foreseeable future, that will in turn have an impact on values.  However, if interest rates can settle, then cap rates will adjust, and the market will quickly get back to a normal market environment.  Many experts believe  future rates increases have already been priced into the market, and interest rates will not continue the pace of increase we have experienced since the start of the year.”

Hybrid Work. People have spoken and they are overwhelmingly in favor of hybrid work according to a new report from Cushman & Wakefield, office demand is returning.  In the two years since the first COVID-19 lockdown, much of the world has returned to pre-pandemic employment levels.  The firm sats that long-term, US office-using employment is expected to grow 50% faster than total employment by the end of 2030 with high-tech jobs forecasted to grow twice as much.  With leasing activity up, the majority of companies who have made decisions are currently planning on hybrid, agile work environments as their leases expire.  Despite the work from home rhetoric, market data shows office leasing volume globally is surging.  The hybrid solution is galvanizing the corporate need for office space as the workplace gets reimagined.  Cushman says the companies that thrive will be the ones that provide employees the choice of where to work, which could require businesses to continue the balancing act they have found themselves in since the onset of COVID.  “Employees need the office to support their desire to learn, make meaningful cultural connections to their organizations, and to engage more deeply with colleagues,” the report notes adding “many employees rate in-office experiences higher than remote work, and the workers who have the most meaningful experiences – typically millennial and Gen Z workers – are the ones who come into the office multiple days a week.”  To compete with talent, corporate leaders will need to create office environments that inspire employees and draw them in by blending home and office environments, as well as the addition of technology, access to clean fresh air, and amenities such as outdoors spaces and multi-use spaces and flexible schedules.  

ABQ Q1 market trends:

Office sector performance has indicated that we have absorbed more office vacancy in Albuquerque in the 1^st Quarter of 2022, an improvement over the national reports.  

As more companies join forces to introduce collaborative office space, hybrid work plans or return to office timelines, material changes in the office sector could boost performance metrics in the near future.