Interest Rates and Real Estate Capitalization Rates on the Rise

Abstract

[Excerpt] Questions about near-term interest rates levels have become particularly difficult to answer with the importance of factoring in both future economic conditions and Federal Reserve Board policy modifications along with their interactions. Despite the difficulty of pinpointing the levels of interest rates during the next 12 and 24 months, some increase in interest rates appears inevitable given the continued and steady growth of an economy that should require less accommodation. Accordingly, heavier discounting of securitized and un-securitized cash flows from capital assets, such as commercial real estate, will impose downward pressure on values. Real estate capitalization rates also embody risk premiums through the discount rate and asset-specific income growth. Changes in both of these components coincident with sustained economic growth will counter some or the entire upward drift in the riskless rate.