Interest Rates, Inflation, and Real Estate Investments

September 30, 2022

Rapidly rising interest rates, inflation, declining asset values, and a shrinking general economy are tearing apart the fabric of the U.S. economy. 

As of this writing (September 29, 2022), the Dow Jones Industrial index has declined $7,573.04, or -20.58%, from its all-time high set almost 10 months ago on January 4, 2022.

interest rates

In 2022, the U.S. Gross Domestic Product (GDP), which is the measure of the value of goods and services in the U.S. economy, declined at an annual rate of 1.6% in the first quarter and by another 0.6% in the second quarter. With two consecutive quarters of negative GDP, the U.S. economy officially descended into recession.

During this same period, the Federal Reserve Bank increased its Federal Funds interest rate (the rate it charges member banks for borrowing from the Federal Reserve) four times in 2022, reaching a current total interest rate of 3.25%, an increase of 3.00% since the beginning of the year.

Due to these Fed Funds interest rate hikes, banks have increased their interest rates on most loans, including home and commercial mortgages, credit cards, and commercial business loans.

How This May Impact Value

The most interesting aspect of our current economic situation is the conflict between the opposing economic forces of inflation and rising interest rates.

On the one hand, general logic says when we have inflation, prices go up. And, as we know, the cost of most types of real estate has risen dramatically in the most recent 24-30 months.

interest rates

But, on the other hand, that same logic also tells us that rising interest rates, including commercial mortgage interest rates, tend to hold real estate prices in place and even reduces real estate values.

The question most people have is which scenario is going to dominate? Inflation or rising interest rates?

To answer this question, we only have to look at the outcome of a virtually identical situation that occurred from 1980 through 1982, when the U.S. economy suffered double-digit inflation and double-digit mortgage interest rates.

During that time, as residential mortgage interest rates peaked at 18½% in late 1981, home sales dropped by 50%, and values dropped between 20-30%, depending on where you were. That market took 15 years to recover to its pre-decline level.

At the same time, commercial loans and mortgages virtually dried up. But because there is no centralized database that tracks sales of commercial real estate in the same way as residential real estate sales are tracked, hard commercial sales numbers are less accurate.

That said, it's widely accepted as fact that commercial real estate sales substantially declined during that period. But more importantly, the value of commercial real estate took very heavy losses as a result of massive vacancies in retail and office spaces. This was due to the loss of retail sales and a decline in service business activity which also resulted in significant job losses, especially in the construction industry, which suffered over 22% unemployment during that time.

The lesson from that historical situation is that as interest rates rise, buyers become scarce. When there are fewer buyers, there's less competition for available properties, which causes prices to decline to make a property attractive to the few buyers in the market.

In our current situation, the types of property in the greatest danger are tenant-occupied properties, particularly those whose tenants rely on consumers of goods and services, such as retailers and real estate-related service companies (e.g., title companies, mortgage lenders, and real estate agencies).

What Can You Do?

Whether you're a business owner who operates your business from your commercial real estate or a landlord who relies on tenants to pay rent, you have to face the reality of the general situation.

And that reality is there's nothing you can do about rising interest rates, inflation, or the declining economy; those things are beyond your control.

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But there are things within your control that you can and should do to help you weather this growing economic storm.

I've listed a few things that will help maintain the value of your real estate and minimize potential problems (these are things that we at Kenneth J. Jones do for our clients on a regular schedule as a free service).

  • All property owners should continually monitor all their expenses, especially their real property tax assessments. They should also eliminate unnecessary items, but not at the cost of sacrificing necessary repairs and maintenance. NOTE: Contact us for a complimentary real property tax assessment analysis. If we find that your property is over-assessed we can help reduce the assessment which will reduce your real estate tax bill and directly increase your net cash-flow.
  • Landlords should regularly visit their property to monitor tenants' business activities. This will help to head off potential rent losses and vacancies.
  • Landlords should also continually monitor the status of tenancies in other properties similar to their's in their local and general market areas.
  • All property owners should regularly drive their local and general market area to see if there are any new vacancies, or changes in the quality of property maintenance.
  • All property owners should take note of any new for sale or for rent signs in their local and general market areas.
  • Landlords should also keep up-to-date on the asking rents in comparable properties to compare them to their own rents. This can help stave off losing tenants to less expensive space when lease contracts come up for renewal.

Get a Complimentary Property Analysis

As a courtesy to commercial real estate owners in our market area, we offer a complimentary property analysis which includes an income and expense analysis, plus a real property tax assessment analysis.

There's no cost and there is no obligation to us for anything.

Contact us if you'd like to learn how we may reduce your expenses and increase your property's value.

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