Commercial mortgage brokers do not have to be economists or experts in monetary policy. But it is essential that a broker has a working knowledge of economics and an understanding of how monetary policy influences the commercial real estate market — including cost and availability of credit. It is almost impossible to discuss commercial real estate without delving into economics, interest rates and inflation, which will eventually lead to discussion of the Federal Reserve and monetary policy.
Inflation was on pace to end 2022 at its highest yearly level since 1981, which has forced the Fed to raise its baseline rates. The central bank is concerned about persistently high inflation and has emphasized its intent to continue rate hikes, despite the pain this will impose upon the U.S. economy.
We can be assured that changes in interest rates have a significant impact on commercial real estate transactions.
Over the past several years, the economy has built up a lot of energy. This is likely to keep inflation higher than the Fed wants, which has led to its reduction of the nation’s money supply and an application of the monetary brakes in an attempt to alleviate excessive spending. Consequently, this will reduce investor demand and prices for commercial real estate.
The Fed’s target inflation rate is 2%. Translated, this means that businesses can increase their prices by 2% each year and the market will remain competitive. Employees can seek a 2% wage increase based on inflation so they can continue to afford the overall cost of living. But if inflation moves beyond this target, it can cause uncertainty within the markets.
To combat inflation, the Fed raised benchmark interest rates multiple times last year and has indicated that further increases can be anticipated. The period of cheap financing is no longer a reality for commercial real estate investors, which likely equates to higher underwriting standards and fewer closed deals.
Inflation impacts every aspect of our lives, including the costs of food, energy and all types of real estate.
The Fed is aggressively raising interest rates to slow price increases. It intends to keep rates high until it is certain that inflation has been tamed. Fed Chairman Jerome Powell has said the central bank’s goal is to increase rates in an attempt to slow inflation but not so much as to cause a recession.
Widespread impact
In the discipline of economics, inflation is a broad acceleration in the prices of goods and services. As prices increase, currency loses value, and this leads to an overall reduction in the purchasing power of the dollar. Quite simply, inflation occurs when everything (including commercial real estate) becomes more expensive, which tends to become a drag on all markets.
