Fed Hike’s Impact on CRE

The Federal Reserve has raised its key interest rate. Is this a good sign for commercial real estate?

Ernie Katai, Berkadia’s executive vp

In a sign of how much the economy has healed since the Great Recession, the Federal Reserve raised its key interest rate from a range of 0 to 0.25 percent to a range of 0.25 to 0.5 percent.

“The way I look at it is this is the Fed’s way of signaling they have some confidence in the economy,” Ernie Katai, Berkadia’s executive vice president, head of production, told Commercial Property Executive. “While the economy has shown some capability in recovery, it’s not where people want it to be yet, and I could almost guarantee it’s not where the Fed wants it to be, but people are somewhat comfortable that this will be more of a methodical, slower approach.”

The appetite for real estate is significant and continues to be strong, and the rate hike’s affect on commercial real estate should be minimal.

“The one thing we noticed with banks is construction money seems like it’s getting tighter and banks are putting their efforts on better borrowers. I think you will continue to see more quality play by the banks,” Katai said. “There probably is a little more impact on construction dollars than people might like to see, but I don’t think it’s anything that will create any real problems.”

According to Katai, one thing the Fed did that people in the business were happy about was telegraph that they were going to do this, so it didn’t take anyone by surprise. What’s critical looking into the future is the pace and timing of any future increases.

“As acquisitions happen, I think people will be very conscious and keep an eye on the rates,” he said. “I think the good news is we continue to see a liquidity on the equity markets providing equity for real estate deals, and that continues to be very strong.”

Compared to its last forecast in September, the Fed raised its expectations for growth next year to 2.4 percent, up from 2.3 percent. It also lowered its projection for unemployment in 2016 to 4.7 percent, down from 4.8 percent.

“I feel confident about the fundamentals driving the U.S. economy, the health of U.S. households, and domestic spending,” Fed chief Janet Yellen said during a press conference. “There are pressures on some sectors of the economy, particularly manufacturing, and the energy sector…but the underlying health of the U.S. economy I consider to be quite sound.”

Also of concern to the industry is a new tax bill, proposed by congressional leaders, which could prevent companies from spinning off their real estate assets into REITs.

“The tax bill, if enacted, would not prohibit such transactions, but would instead make them taxable in a manner that could produce a substantial disincentive to engage in these practices going forward,” Kevin Anderson, a tax partner with BDO’s National Tax Office, told CPE. “Its primary impact will be on corporations that currently conduct one or more active businesses but seek to separate their real estate from their business operations, such as Darden, which completed a spin-off, or McDonalds, which considered but did not pursue one.”

He added that it will not affect the division of one REIT into two REITs, nor will it affect the spin-off of certain taxable REIT subsidiaries by existing REITs. Thus, as a practical matter, it will slow down or halt altogether the separation of real estate from operating businesses through spin-off transactions, as such transactions would now be taxable.

Affected transactions will be taxable under the new rules if they are completed on or after Dec. 7, with one exception. If a corporation had submitted a request for a private letter ruling with the Internal Revenue Service on or before Dec. 7 that is still pending as of that date, it may pursue the transaction without becoming subject to the new legislation.

“For transactions completed after the effective date of the legislation, the corporation making the spin-off would recognize taxable gain as if they had sold the real estate assets for their fair market value,” Anderson said. “In addition, shareholders could recognize taxable dividend income or capital gain, depending on how the transaction is structured.”