Blog

There has been much talk recently about what the Federal Reserve’s first interest rate hike since 2006 means for the U.S. economy as a whole. Here we take a look at the impact of rate hikes (current and future) on commercial real estate, examining first the prospective disadvantages and then the potential benefits.

Figuring this out isn’t straightforward, as interestrate changes have multiple impacts on commercial real estate (CRE). Further, the very causes of the Fed decision to raise interest rates may signal that other economic factors are at play, and these, too, may impact CRE.

Further complicating things, the timing of the rate hike coincides with the “maturity wall” of commercial mortgage-backed securities that need to be refinanced within the next two years. The maturity wall means there will be many borrowers who need refinancing in any case because their loans are maturing, while the rate hike could prompt those borrowers to seek out refinancing sooner rather than later.

It is worth noting that since the recent rate hike is small and the rate remains low – the quarter-point increase raises the target range to 0.25%-0.5% – the current hike may not have a massive effect on its own, but subsequent hikes are predicted for next year.

The bad news: Why rate hikes could be bad for CRE

Access to capital is one of the main drivers of any real estate deal, whether acquisition or new development. Higher interest rates mean that borrowers have to pay more in interest than they

would if they had borrowed the same amount of money before.

In the short term, these higher rates may prompt concern about future rate hikes and could drive borrowers to seek refinancing now, before rates rise again. Others may wait, and the higher rates could cause greater friction. In the extreme, higher interest rates may constrain property deals, as they can become a barrier to entry for borrowers, who now have to pay more to access money for loans or mortgages.

Cost of capital is a second consideration, as higher rates mean that the “rental price of money” has gone up. This could lead to borrowers paying more interest to lenders (a good thing for financial institutions). However, it could also lead borrowers to get smaller loans in the first place if they calculate that they would not be able to keep up with interest payments on a larger loan, forcing them to either put up more equity or target lower-priced properties. Further, riskier loans (like construction loans) and riskier assets may be even harder to finance efficiently, given the added risk premiums.

Higher capital costs could also increase default risks. These may be bad for lenders, too… that is, unless they are non-traditional “vulture” players employing a loan-to-own strategy and secretly hoping for defaults in order to seize properties. In an extreme situation, if these defaults start to spread, they can ultimately be bad for the economy as a whole.

Property valuations may also be affected. To explain, the copious amounts of cheap debt capital sloshing around the market have buoyed property values. An extended period of increasingly expensive debt, by contrast, may cause valuations to erode.

Property players are not the only ones affected by these changes; the lending institutions themselves may be affected as well. Knowing that higher interest rates erode both borrower net income and property value, lenders could respond by tightening lending standards or loan collateralization. For instance, they could limit lending in riskier markets or reduce the loan-to-value ratio, effectively meaning that they would require a greater proportion of money up front before issuing a loan.

They might also require more collateral to back up their loans. Current loan portfolios are potentially put at risk, not only new lending activity. While lenders can reduce their exposure on new loans by imposing stricter lending criteria, their exposure on existing loans could increase. As noted above, default risks can have an impact on all players.

If a property owner has a net operating income of $1 million and a capitalization rate of 3.75%, for instance, an interest rate hike of just 0.25% will trigger a cap rate hike (and a lower property value) that results in a 5% rise in the loan-to-value ratio, which is a key measure of risk. This could potentially push up a loan from a high but acceptable LTV of, say, 75% to a riskier LTV of 80%, which means that the borrower’s equity will be reduced to just 20% of an existing investment. In the pre-crisis bubble, many lenders were prepared to issue loans for particularly high LTVs.

David vs. Goliath | Long Island Business News

170 Michael Drive, Syosset
Cultural Arts Playhouse Academy leased 8,120 square feet at 170 Michael Drive in Syosset. The new location will feature two new performance spaces, an 80-seat main stage and a 50-seat black box area. Jeff Jurick of Woodburybased Premier Commercial Real Estate represented the tenant and the landlord, 170 Michael Drive LLC in the lease transaction.

170 Michael Drive, Syosset
Long Island Swimming leased 13,000 square feet at 170 Michael Drive in Syosset. The Garden City-based swim school and club is expanding its operations with two indoor pools at the new location. Michael Ventre of Windsor
Commercial Real Estate represented the tenant and David Chinitz of Park Place Realty Group represented landlord 170 Michael Drive LLC in the lease negotiations.

147 East Second St., Mineola
The law firm of Hannum Feretic Prendergast & Merlino, which specializes in insurance coverage and defense litigation, as well as construction defect, labor law, and trucking and product liability, leased 2,500 square feet office
space at 147 East Second St. in Mineola. The tenant was self-represented, while landlord Great Neck Saw Manufacturers was represented by Chuck Syage of Hunt Corporate Services in Plainview.

2115 Jericho Turnpike, Commack

Bar Louie, a national bar-and-grill restaurant concept, leased a 9,100-square-foot building on 2 acres at 2115 Jericho Turnpike. The site was formerly occupied by Chuck E. Cheese. Anthony Russo of Katz Associates represented the tenant and Jonathan Winzelberg of Sabre Real Estate Group represented landlord Cinron Associates in the lease transaction.

Babylon proposes state’s first craft brewing incubator | Long Island Business News The Town of Babylon Industrial Development Agency has unveiled a plan to convert a blighted building into the state’s first business incubator dedicated to craft bar.

Babylon proposes state’s first craft brewing incubator | Long Island Business News The IDA would spend $12 million to buy, revitalize and equip a former missile component facility at 1305 S. Strong Ave. in Copiague.

Sears Roebuck & Co. will close its carry-in repair office in Melville and layoff its 31 employees there, according to a
filing with the New York State Department of Labor.

The layoffs and closing of the Sears appliance repair office at 120 Spagnoli Road are scheduled for Nov. 22. A Sears
official did not respond to a request for comment on the Melville layoffs.

The chain closed more than 200 Sears and Kmart stores in 2014. Its parent company, Sears Holdings, has formed a
real estate investment trust called Seritage Growth Properties to extract value from its real estate holdings and
replenish its cash as it tries to turn around its slumping business.

Sears Holdings plans to sell and lease back about 235 properties, most of them Sears and Kmart stores, to the
REIT. The company expects $2.6 billion in proceeds. The transaction also includes the purchase of interest in its
joint ventures.

In April, Sears struck three real estate transactions, including getting $150 million from a joint venture with mall
operator Macerich. It also has deals with General Growth Properties and Simon Property Group.

In June, Sears Holdings reported that its revenue fell to $5.9 billion for its first quarter that ended May 2, 2015,
compared to $7.9 billion in the same period a year ago.

Sear Holdings said same-store sales fell by 10.6 percent during its quarter-to-date period that ended on July 25,
compared to the same period a year ago. That followed a drop of 11 percent in the first quarter.

An innovative incubator program for aspiring entrepreneurs is expanding to include Long Island shopping centers.

The effort by New Hyde Park-based Kimco Realty, which debuted in California three years ago, offers fledging retail,
restaurant or service businesses one year of free rent at some of Kimco’s shopping centers, including six on Long
Island.

Those who qualify for the incubator program can set up shop in retail spaces of up to 2,500 square feet, including some pre-built restaurant locations, according to a company statement, though they must also pay reduced first year property charges.

The entrepreneurs can access Kimco retail business counselors and can extend their stays with an additional fouryear
lease option.

“At Kimco, small shops are an integral part of our neighborhood and community shopping centers, adding diversity,
value, and a local touch to our tenant mix,” Conor Flynn, Kimco president and COO said in the statement. “Providing
operational and financial support through the critical start-up incubation years is part of our commitment to
encourage small businesses, as well as women, minority and veteran-owned businesses, to open their doors and
flourish.”

The Long Island shopping centers where incubator space is available include the Market at Bay Shore, the
Centereach Mall, the Pathmark Shopping Center in Centereach, Hicksville Plaza, Manetto Hill Plaza in Plainview and
the Syosset Shopping Center, according to Kimco’s website.

Applicants for the program called Kimco Entrepreneurs Year Start must provide a business plan with specific goals
and objectives, and demonstrate adequate funding for their venture. An endorsement, certificate, degree, or letter
of completion from small business educational classes, or a college or university is also recommended.

Earlier this year, Kimco announced an alliance with NxLeveL Education Association to provide 30-hour educational
programs for start-up entrepreneurs and prospective business owners interested in opening their first retail store,
restaurant, or service operation.

A publicly-traded real estate investment trust, Kimco owns interests in 727 shopping centers comprising 107 million
square feet of leasable space across 39 states, Puerto Rico, Canada, and Chile.