Patrick is founder and CEO of CARROLLa national real estate company that combines institutional investment capacity with real estate activities.
The global pandemic and other international situations have created uncertainty in the capital markets. As uncertainty increases, interest rates fall. Now multiple global crises have converged to yield a very different scenario, and the Feds are raising interest rates anyway. While rising interest rates may deter US buyers, we are seeing an influx of foreign investors from other countries.
Rising interest rates
We are in a unique situation. If a recession was imminent in the past and the FED did not have to compensate for inflation, interest rates would be lower. When there is fear in the market, the cost of interest rates usually falls, and the FED wants people to go out to borrow and buy products. At that time, people are hoarding their money, so it is an incentive for businesses and people to go out and buy. Now the market and oil supply have been affected, which will push up the price of oil and deplete disposable income. This has a knock-on effect on the economy, affecting the real estate sector.
The economy will suffer if the FEDS raises interest rates too high and too quickly. There are probably trillions of dollars in adjustable-rate debt. We call this floating rate debt. When the FED raises interest rates that much, people’s assumption about where interest rates will be is going to be distorted. Rising interest rates will drive up the cost of capital on existing projects that cannot be offset by increasing your risks so quickly. Evaluations will also affect how high the risk-free rate is, which is where PE multiples come from. The higher the risk-free rate, the lower the multiple for equities. So it would also do a number in the stock market. The biggest risk we have is that the FED will blow it up and raise interest rates too fast and too much.
Supply chain issues
The Covid-19 crisis in China continues to crush the supply chain, driving inflation up. We can’t get materials, we can’t get goods, and there’s a scarcity effect, which drives up costs. Global economic disasters and interest rate hikes can be a recipe for disaster.
Foreign real estate investment in the US
According to an Deloitte reported that as restrictions on international travel were lifted, foreign investment in commercial real estate in the US recovered in the second half of 2021. the second strongest H2 since data began in 2001.
In the real estate field, foreign investors continue to look to U.S. real estate as a safe haven, and I believe the current crises will bring more foreign investors to the U.S.
Hedging against inflation
Foreign investors will continue to look to the US despite rising interest rates. Income generating real estate, income generating real estate, anything you can rent and earn cash is free cash flow return on invested equity. With properties that have cash flow – think apartments, industrial estates, hotels, anything you can buy and rent – the cash flows after your debt service, especially the properties that allow rent adjustments. Your interest costs rise as employee expenses rise, inventories rise, and you can at least keep up with that by increasing your rents.
Income-generating properties that allow for rent adjustments, such as hotels and apartments, break inflationary heads – with the idea that you can pass on costs incurred. You can offset cost increases with higher rents, ie an inflation hedge. These opportunities will continue to attract foreign and domestic investors.
Despite inflation, rising interest rates and many global crises, I expect that foreign investors will continue to flock to the US to take advantage of political certainty and stable growth. The volatility of the global market has far-reaching implications, but history has proven that US real estate will remain a safe investment.
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