The recent increase in the Federal Reserve's fed funds rate (25 bps; target rate of 5 to 5-1/4 percent) carries notable results for the industrial real estate sector in Orange County. With real GDP growth predicted to be around 3% this year and the market already factoring in several rate hikes by the FOMC, it is crucial to grasp the potential impact on industrial real estate.
A primary result of the FED funds rate rise is the increase in borrowing costs for businesses. SBA rates are expected to break into the 6s for the second time this year. This will affect the business's capacity to allocate resources for new initiatives or expand its operations, potentially leading to a decline in demand for industrial real estate. However, it is essential to recognize that the effects of the FED funds rate increase are not wholly negative for the industrial real estate market, particularly in Orange County. Elevated interest rates can yield better returns for investors (higher regional lease rates), attracting more capital to the sector and possibly boosting demand for industrial properties. With Orange County's bubble-like economy/attributes, we expect industrial real estate to continue to hold the line moving into the summer months.
Another outcome of the FED funds rate increase is a slowdown in the growth of new construction projects. Higher borrowing expenses can make new ventures financially challenging for developers, potentially hindering construction rates. This may result in a tightening of the industrial real estate market as the supply of new spaces becomes limited. Already funded projects will mostly continue with the hopes of a stronger economic environment upon completion.
Furthermore, considering the effect of the fed funds rate increase on this year's loan market and the upcoming commercial real estate loan maturities is vital. Although making accurate predictions is challenging, increased volatility in the loan market should be expected. There are approximately $162 billion in commercial mortgages scheduled to mature in 2023 with more coming in the next four years, peaking at $550 billion in 2027 (Bloomberg).
All in all, the FED is finally showing signs that there is potential to start tapping the brakes through the next rate hikes. Orange County's market, still with a historically low vacancy (1.46%), has the demand that is needed to float property values until we can bridge the gap. And with more subleasing opportunities coming online, there is plenty of opportunity for businesses to go about their growth plan if need be.
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