Interest rates weigh heavy on 2005 outlook

Real Estate Weekly, March 30, 2005

A more robust economy could actually challenge office-building values in the months ahead, according to real estate industry observers.

Interest rates are expected to rise through 2005 and 2006, pushed up by an improving economy and growing inflationary pressure.

That trend has the potential to stem the record rise in prices paid for office buildings in recent years and to put some building owners at risk, according to real estate experts at an event held recently by the New York Metropolitan Chapter of the Appraisal Institute.

"Commercial real estate has benefited enormously from the very low interest rates of recent years," said Mark Zandi, chief economist and cofounder of Economy.com Inc., alluding to the very high sale prices achieved for office buildings in recent years.

But despite improving space absorption, lower vacancy rates and firmer rents, Mr. Zandi said, due to the prospect of rising interest rates, "pricing for commercial properties will be tested in the coming year."

According to Craig Thomas, senior vice president and director of Research and Research Systems at Torto Wheaton Research, higher long-term interest rates will lead to flat or rising cap rates, exposing those buildings struggling to produce operating income.

This will have serious implications for those assets' market value.

"Buildings struggling to lease-up or those scheduled to have leases roll-down to market rents will be exposed," said Mr. Thomas.

"Fortunately, market fundamentals are now improving, helping shelter well-performing assets."

Mark F. Pomykacz, MAI, president of the New York Metropolitan Chapter of the Appraisal Institute and an executive at Federal Appraisal & Consulting, said that the relatively low cost of capital in recent years definitely added to real estate's attractiveness as an investment class. "It's very plausib1e that a significant rise in long-term interest rates will impact some investors and deter others," Mr. Pomykacz said. "But with leasing fundamentals continuing to improve, the market could also take higher rates in stride."

The New York Metropolitan Chapter of the Appraisal Institute regularly hosts events featuring some of the industry's most prominent and respected individuals. For more information visit www.aimetrony.com.