Fed rate hike shouldn't worry hotel investors—at least not yet

The Federal Reserve's decision to raise its benchmark interest rate was never a real mystery; it was one that was expected. The move increased the target of the federal funds rate, which banks use to lend to each other overnight, by 25 basis points and to a range of 0.50 to 0.75 percent.

Still, it was only the second rate hike in the decade, and the widespread assumption is that 2017 will see more raises—as many as three more.

The Fed's decision to bump rates up from near zero is a signal of the U.S. economy improving to the point where it doesn't any longer need the Fed as a crutch. However, a higher rate means things—like mortgage and credit card rates—will become more expensive.

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In the hospitality industry, those who make their livelihood buying and selling real estate were, up to now, operating in unprecedented good times, buoyed by cheap debt and market liquidity.

Are the good times over?

Not yet, according to two hospitality experts we spoke with.

"I am not confident that a single 25 bps fed rate increase will have any impact on new loans," said Ryan Meliker, managing director of equity research, REITs and lodging at financial services firm Canaccord Genuity. "This hike was well telegraphed and was already built into longer-term interest rates."

For Mike Cahill, founder of real estate advisory and brokerage firm HREC, the Fed's rather miniscule lift of the key interest rate should have relatively no impact on future short-term investment in the hospitality sector.

"Mathematically, yes, there should be impact in so much as 70 percent of your cap rate is your interest rate; however, from a practical point of view, 25 basis points is so small that we won’t see it quantified in the sales price."

Cahill and Meliker are in agreement over the present and the future. More rate increases suspected in 2017 could prove to have a lasting impact on transactions, proving to make developers and buyers rethink their positions when looking to strike a deal.

"Continued rate increases would change the slope of the yield curve and make loans more expensive and while that has not happened, yet, it seems like the Fed is more inclined to continue to raise rates in 2017 than they were in 2016," Meliker said. "That will raise interest expense, which will make loans more expensive and potentially translate into fewer new projects penciling out."

Likewise, for Cahill, if more increases are on the horizon, it will have consequential impact. "If after a year it accumulates and interest rates are up 100 or 75 basis points, that will be meaningful to a buyer," he said.

Interest-rate hikes, however, do not have to be perceived as a storm cloud hovering overhead. To be sure, rate increases follow an upward trend in the economy. Consider Fed Reserve Chair Janet Yellen, who came out and said that the U.S. now has strongest job market in nearly a decade.

It's something not lost on Meliker. "As it pertains to hotel financing, historically, rising interest rates go hand in hand with economic improvement and inflation," he said. "Those are trends that are very positive for the hotel industry. Thus, even with rising interest rates, the hotel industry could see an increase in cash flows from hotels, which will drive easier financing and potentially higher loan values."

 

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