Those waiting on bated breath for interest rates to rise finally got an answer Wednesday after the Federal Reserve announced it would aim to increase its benchmark interest rate, potentially cooling down a hot senior housing market.
The historic move is a positive sign for the economy—which the Central Bank has deemed strong enough to absorb higher interest rates—but will also likely impact senior housing real estate by raising the cost of capital and potentially slowing down development pipelines.
“It’s going to be a significant change for lenders and borrowers,” Beth Mace, chief economist and director of capital market outreach with the National Investment Center for Seniors Housing & Care, told Senior Housing News.
Federal Reserve Chairman Janet Yellen announced Wednesday that the Central Bank will raise its benchmark interest rates 0.25%, citing an improving labor market, better real estate environment and confident inflation objectives.
“A modest increase in the federal funds rate target is now appropriate,” Yellen said in a live statement immediately following the announcement Wednesday.
The news is a big shift for all commercial real estate sectors.
“It changes the cost of capital and that will feed into overall profits,” Mace told SHN.
The news affects buyers and sellers in the space differently, says Jeremy Stroiman, CEO of Evans Senior Investments (ESI).
“For sellers, people are beginning to realize that they may have missed the 52-week high for stock prices,” Stroiman told SHN. “We’re now going down the mountain. Uncertainty among sellers is going through the roof because they are wondering if they missed the window. On the buy side, it’s the reverse.”
The Reality for REITs
While the core of the American economy has rebounded, all three of the “Big Three” health care real estate investment trusts (REITs) with significant senior housing portfolios—Ventas Inc. (NYSE: VTR), Welltower Inc. (HCN) and HCP Inc. (NYSE: HCP)—have seen their stock values take a dive over the last year. However, the senior housing sector isn’t slowing down, according to data from Fitch Ratings.
Development pipelines are up this year, comprising 5.2% of gross assets for the U.S. equity REIT sector, according to Fitch. Last year, development was just 4.8% of gross assets. By comparison, REIT development peaked at 7.6% in 2007.
Interest rates are expected to continually rise over the next several years, potentially slowing down the rate of acquisition across all commercial real estate sectors, including senior housing. Rising development pipelines may also have an impact on cost of capital as new supply comes on line, coupling challenges REITs face with interest rates. REITs in particular have more exposure when interest rates change.
Rising Cost of Capital
With stock prices trending downward and the cost of capital rising, health care REITs have seen their credit lines swell in the past few years, prompting some worries among industry experts. Lower stock prices have contributed to less accessibility to equity markets for some REITs, which may be why some are drawing on higher lines of credit to fund developments. The average REIT was trading 16% below its net asset value (NAV), Fitch reported at the end of the third quarter.
“All the publicly traded REITs got killed last year,” says Stroiman. “It just creates uncertainty with analysts and where the RETIs get their credit line. …The publicly traded space wasn’t even close to the private space. This next year, I think the buyers are going to be investing the most on the private side.”
However, credit volumes reached levels last seen during the height of the economic recession.
“Outstanding revolving credit facility balances at the end of the period were at their highest levels since December 2008,” according to a third quarter report from ratings agency Fitch Ratings.
Median credit utilization percentages rose to 22% as of June 20, 2015, a significant jump from 13.6% seen at the end of 2013, according to Fitch.
Fortunately, REITs have been preparing for the announcement for quite some time, as the Fed has been open about future steps to bring interest rates back up. The increase is also likely to be gradual with limited immediate impact as the economy continues to strengthen.
It is unlikely that interest rates will rise sharply at any point over the next few years, according to Yellen, who stated that the Fed has no policy in place to spike rates at any set point in the future. Rather, the Federal Open Market Committee (FOMC) will continue to monitor economic benchmarks such as inflation, employment and wage levels and GDP. Yellen cautioned that increasing rates too quickly could push the economy back toward recession.
“The market is taking the rise into account,” Mace told SHN. “The impact on REITs has largely been taken into account as well.”
Written by Amy Baxter
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