Blog | 16 Jun 2022

In light of the recent Fed rate hike, look to apartments during periods of high inflation

Christopher Babatope Bio

Christopher Babatope

Associate Director, North America Real Estate Economics

The Federal Reserve is worried about inflation and has made a big step to tackle it, raising the federal funds rate by a further 75bps at its June FOMC meeting – its biggest rate hike since 1994. Our baseline forecast scenario assumes that the Fed will be successful in its efforts to tame inflation, while also engineering a soft landing for the economy – with structural forces placing further downward pressure on inflation over the medium-to-long term. However, it is worth highlighting what cities and sectors have historically performed best during similar periods of elevated acyclical inflation*, as sector-based performance has tended to vary significantly. Based on recent analysis of property total returns and inflation, the apartment sector is best positioned to weather the inflation storm in the US. Conversely, office returns, specifically within gateway markets, have typically fared worse during periods of acyclical inflation.

While our analysis suggests that apartments have typically performed best during similar periods of high acyclical inflation, the key mechanisms through which investors will be impacted by rising rates is higher cost of capital and pricing relative to the risk-free rate (10-year US Treasuries). The unpredictability, and recent rise in debt cost have stymied some new acquisitions. Additionally, as explored in our recent debt cost, some core commercial real estate segments (e.g. gateway industrial markets) are due a pricing correction, to generate a low-risk interest coverage ratio at a reasonable LTV. The general “stickiness” of valuation yields makes the scale of such a correction more difficult to forecast. However, as we adjust our near-term macroeconomic outlook, we will have a clearer view as to the implications for US real estate.

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