The Federal Open Market Committee concluded its first meeting of the year yesterday. Looking back at the leadup in 2021, the Fed delivered on its promise to maintain low interest rates until economic fundamentals showed stability–particularly low unemployment numbers, which remains at 3.9 percent, down from a high of nearly 15 percent. After a rapid normalization of the jobs market, the concern now is inflation, which hit seven percent year-on-year at the end of December 2021, the highest since June 1982.

“Inflation remains well above our long run goal of two percent,” said Fed Chair Jerome Powell in the press conference. “Bottlenecks and supply constraints have extended longer than anticipated.” He also added that drivers of inflation included price increases in more goods and services and the lasting effects of COVID-19, but the Fed expects inflation to decrease throughout 2022.

Economists generally expect three to four interest rate hikes of quarter percentage points each over the course of the year in response, but for now, the Fed has decided to leave the target range for the federal funds rate as is. Powell added that they do project to raise the target for the federal funds rate soon.

“The drastic expansion of the Fed's balance sheet to buy bonds and promote liquidity, while largely unprecedented, was effective,” said Matt Swerdlow, Director, Capital Markets, Ariel Property Advisors. “Now the Fed must get back to more normalized monetary policy to maintain affordability for not only tenants but also real estate investors especially at a time when labor shortages and supply chain constraints are driving up real estate costs.”

Lenders are still displaying a growing amount of enthusiasm for real estate deals, but these market constraints, as well as some fears about a housing bubble in spite of short supply, are leading to stringent underwriting standards. Additionally, the omicron variant is creating ongoing uncertainties for the construction labor force as well as the short-term prospects of the office, hospitality and retail markets.

Later this year, the Rent Guidelines Board, a mayoral appointed body, will set new rent growth rates for NYC’s ~1 million rent stabilized units. “How they digest the new inflation numbers will impact what rent increases landlords can levy on rent-stabilized tenants,” said Swerdlow. “There is a lot at play that will affect the lending environment and long-term prospects for investors and borrowers.”

Property tax assessments, insurance premiums and utility costs are things that lenders take into consideration when analyzing an opportunity to lend. Expense increases may have a negative impact on a properties net operating income and appraised values. Lenders are also monitoring legislation and its effects in major metro areas, such as NYC. Local Law 97, for example, sets progressive carbon reduction benchmarks for properties larger than 25,000 square feet. The responsibility for meeting these lies on owners, entailing capital improvements or carbon fines for missing the mark. The first round of requirements occurs as soon as 2024. The end of the eviction moratorium, meanwhile, is creating a sigh of relief from landlords, but the Good Cause Eviction bill could ultimately codify permanently many of the same revenue restrictions in place under the moratorium.

End Note: The End of Libor

The London Interbank Offered Rate, a.k.a Libor, once a standard for pricing floating rate mortgages will no longer be used on new loans in the US as of the end of December 2021. Instead, the US will be using the Secured Overnight Financing Rate (SOFR), which is based on the rates U.S. financial institutions use on overnight loans, typically Treasury bond repurchase agreements.

“While Libor will continue to be published through 2023, banking regulators have advised to not issue any new Libor-based financial contracts after December 31,” said Swerdlow. “To preempt this, many lenders began drafting Libor transition language into loan documents in anticipation of this date. If so, it is important to understand which alternative your loan now floats over. The transition to SOFR will also prompt the need for the review of existing contracts in the commercial real estate market, as interest rate and fallback provisions could be affected. Many current variable-rate loan agreements may ultimately need negotiated terms, as there may be too much uncertainty in the transition period before industry consensus on rates.

Overall, there were few surprises in the Fed’s press conference and the resolve to adhere to the previously announced recovery plans. In the commercial real estate industry, this should indicate confidence in market tailwinds including improved jobs numbers, lender enthusiasm and positive long-term prospects across major asset types.