Interviews

Real Estate Investing with the Risk of Rising Interest Rates

Spencer B. Haber, CEO, H/2 Capital Partners LLC
April 6, 2015

Spencer B. Haber, the CEO and Chairman of H/2 Capital Partners and Chairman-elect of the Zell/Lurie Center's Advisory Board, recently sat down with Martin Bucksbaum Professor of Real Estate, Finance and Business Economics & Public Policy, Nancy A. Nasher and David J. Haemisegger, Director of the Zell/Lurie Real Estate Center, Joe Gyourko to discuss real estate investing when there is a risk of risking interest rates

Overview

• The effect of rising interest rates is hard, or impossible, to know given the historical uniqueness of our economic circumstances—but the risk could be substantial
• Rising interest rates are likely to cause a steepening of the "credit curve"
• Cap rates will likely be less sensitive to initial increases in interest rates; but a "tipping point" is likely to occur, after which cap rates will adjust

Executive Summary

Spencer B. Haber, the CEO and Chairman of H/2 Capital Partners and Chairman-elect of the Zell/Lurie Center's Advisory Board, recently sat down with Wharton real estate professor Joe Gyourko to discuss real estate investing when there is a risk of risking interest rates. Haber explains that it is difficult to anticipate how problems from the cessation of 30 years of secular decline in interest rates and six years of extraordinary monetary stimulus might be manifested. The potential transition is unprecedented, Haber says, and it is likely we will see things in this part of the monetary cycle that no one has seen before. One way that expectations of rising interest rates might affect investment, Haber says, is through a steepening of the "credit curve." A credit curve measures the difference in yield an investor would need to take additional risk. That curve compressed during the era of low interest rates, as the hunt for yield induced investors to accept a smaller amount of additional return when taking more risk. If investors anticipate higher interest rates, they will want to be compensated more for taking more risk, and the credit curve will steepen. Another area where rising interest rates will affect commercial real estate, Haber said, is through cap rates. Haber believes that rising interest rates will have little effect on cap rates at first, but eventually will exceed a tipping point and produce higher cap rates. It is hard to tell what that tipping point might be--and it may vary across real estate markets and sectors--but what should count most for institutions is the risk of cap rates reverting to historically higher levels over a five-to-seven year holding period. This cap rate risk, Haber said, has already led some institutions to actively consider how to reduce their exposure to the interest rate risk embedded in their commercial real estate equity allocations.

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