December 22, 2016
2017 Real Estate Outlook

Rising rates will pressure/dampen realty investment returns

Jay L. Morris

The year 2016 has been very active for commercial real estate in Connecticut and throughout the nation. All real estate has been the beneficiary of so many years of stimulus through incredibly low interest rates.

In July, the 10-year U.S. Treasury yield hit a record low of 1.336 percent. The low cost of financing has stimulated a tremendous amount of commercial real estate sales across all commercial sectors including office, multifamily, medical office, retail and industrial. The volume of sale transactions and prices have finally reached levels not seen since 2007, before the last recession.

The main area of commercial real estate in Connecticut that has been lagging the nation is the lack of new construction. I believe that this is because Connecticut is one of the most expensive states to do business in and we don't have a competitive economic incentive program. There are not enough businesses moving into the state and we have a hard time retaining our existing businesses, which are being lured away by other states that are offering incentives and a lower cost of doing business.

In Connecticut, the greatest obstacle affecting economic growth is our unfunded pension liabilities and large pending deficits in the city of Hartford and the state as a whole. In addition, we still have an inheritance tax driving out our wealthiest residents, many from Fairfield County. As the highest income taxpayers move out of Connecticut, the state will continue to lose tax revenue, which will further weaken our economy.

We need to come up with a more competitive economic development program and a lower tax structure. When I visit other cities throughout the country, I see cranes in the sky and new construction everywhere. In Connecticut, cranes are almost non-existent except for our only beacons of growth: health care and multifamily residential development.

We have an aging population and the demand for easy access to health care is greater than ever. Hospitals are trying to support their communities by locating medical services in the towns that they serve. The state needs to recognize that hospitals are a huge generator of employment and economic growth, and they should be supported.

As for multifamily development, Connecticut has a large inventory of older apartment complexes from the 60's and 70's. Today, there are many multifamily developments underway or in the planning stages in the majority of towns throughout the state. In fact, there are so many new units scheduled to open at the same time, we may soon be reaching a point of saturation. This multifamily explosion is not unique to Connecticut — it is occurring everywhere. In fact, this may be the next national bubble.

For the coming year, the new White House administration's goals are to stimulate the economy with job growth by reducing regulations and taxes. With employment and wage growth, the demand for commercial and industrial space should increase throughout various markets. This should continue to fuel commercial leasing and reduce vacancy rates.

However, while the new administration's objectives may be good for the economy, it could have an adverse effect on investment real estate because of increasing interest rates. As wage growth and inflation begin to creep up, the Fed will follow a policy of monetary tightening through higher interest rates to keep inflation in check.

Since the election, we have already seen an uptick in interest rates from around 1.8 percent before the election up to 2.466 percent (as of Dec. 9). This is a tremendous increase for one month, and the Fed is expected to continue with moderate increases throughout 2017.

Higher interest rates typically have a dampening effect on all types of real estate, but especially on investment real estate.

Bottom line: To create economic growth in commercial real estate, Connecticut must get its long-term obligations and spending under control, and reduce the cost of doing business here so we are able to attract new businesses from other states and around world.

Jay L. Morris is managing partner of O,R&L Commercial LLC's Hartford County office in Rocky Hill.

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