How Presidential Elections, and Transfers of Power, Affect Commercial Real Estate

With the election in the rearview mirror, and a new administration set to takeover operations at 1600 Pennsylvania Avenue in January, it’s time to look ahead. But, one topic we wanted to explore that was relevant in the run up to the election, and should still be relevant now as we transition to a new administration, is what effects a presidential election has on commercial real estate.

During election years, it’s not uncommon for many investors to adopt a “wait and see” position due to the uncertainty of a new administration’s, incumbent or otherwise, impact on trade policies, interest rates, and tax law. Beyond the fear of the unknown, a new administration, Republican or Democrat, doesn’t necessarily lead to chaos within real estate markets. There may be, though, new policies put in place that could affect valuations and overall return on investment of commercial real estate property.

The four things most likely to be affected by a Presidential election are:

• Cap Rates
• Tax Laws
• Trade Policies
• Appreciation Rates

Cap Rates

A cap rate is a tool frequently used to indicate “the rate of return that is expected to be generated on a real estate investment property. This measure is computed based on the net income which the property is expected to generate and is calculated by dividing net operating income by property asset value and is expressed as a percentage.” Low cap rates indicate the overall risk assessment and return on investment (ROI) are low, while high cap rates indicate high risk and high return.

Normally there are multiple factors that can affect cap rates, but during an election year there is the added variable of changes in interest rates as a new administration could cause rates to fluctuate. There is also the added risk, or reward, of the market reacting to new policies, which could affect available inventory.

Tax Laws

Depending on which party has a majority in Congress, it is not uncommon to see changes or updates to current tax laws when a new administration comes in. When looking at laws that affect commercial real estate, the ones which could have an impact pertain to credits, deductions, and liabilities. Tax laws can be a double edged sword when it comes to commercial real estate, as new deductions could make a property an even better investment, while an increase in tax liability when a property is sold will cut down on the net profit the seller makes. As of this writing there is projected to be a divided, or at the very least balanced Congress, which makes it harder for either party to affect change for tax policies affecting commercial real estate.

Trade Policies

While less likely to impact commercial real estate, trade policies can affect different segments of the commercial real estate market. Varied industries or regions can be disrupted by changes in trade protocol with a foreign country, which could trickle down to users and owners of commercial real estate.

Appreciation

Appreciation rates can be affected by the uncertainty an election year brings, as commercial property prices tend to rise slower in an election year as the market waits for the election results. Historically, this has benefited property buyers.

Other Potential Impacts

What elections don’t do is upend commercial real estate returns. A recent report which pulled National Council of Real Estate Investment Fiduciaries Property Index data from the present back to the 1970s, showed that ROI for institutional investors tended to do well under both Republican and Democratic administrations, averaging better than 8.5 percent annually. The report shows that investors should focus on economic cycles, interest rates, and developments in relation to COVID-19 to determine property and leasing trends, and fundamentals.

The election, ultimately, won’t have an immediate impact on the real estate market. While investment markets will be affected, those effects will happen over the course of the administration’s time in office, and will hinge on how policies affect spending trends that drive growth and industry.

That doesn’t mean industry professionals aren’t watching the election closely, though. In a survey conducted by Berkadia, both investment sales professionals and debt professionals said that the election was one of the most important issues impacting multifamily. There is possibility for disruption in the multifamily market if eviction moratoriums continue and there is no program put in place that backstops landlords.

While we could see changes to the 1031 Exchange program and the Opportunity Zone program under the Biden administration, the long-term effects won’t be felt for a few years, until we see how the market reacts to the laws and policies the new administration puts in place. Regardless of political leaning though, investors should feel confident that their commercial real estate investments should perform well, no matter which political party is in charge.

Did the Fed Indicate Cap Rates Will Rise?

According to the Wall Street Journal the last time the central bank had its short term interest rate more than nominally above zero, was some 2400 days ago. At that time, US Airways flight 1549 landed safely in the Hudson; the Steelers beat the Cardinals in the Superbowl; it was a blue moon ago! 

Seriously, if you are into blue moons, Friday July 31^st actually is a blue moon. 2009 was also before current Fed Chair, Janet Yellen had been sworn into her post. Now in the heat of the summer, after their most recent meet, there is speculation that the Fed may consider setting the clock back to pre-2009, and raise the interest rates.

Indications are speculative. Bill Belichick gives away more in his press conferences than Yellen does in hers. Still with three meetings left in the year, and the major economic indicators going from yellow to green, the Fed may consider a raise. If that happens, what will happen to the commercial real estate values and their capitalization rates?

The capitalization rate, or cap rate, is on indicator of a property’s value in the market. It acts like a yield on a bond. Baked into a cap rate is the risk profile for the property, the buyers assessment of value and the buyer’s cost of capital. As cap rates increase values of properties go down. So would it follow that a rise in the central bank rate would indicate a rise in cap rates and a decrease in commercial real estate? Spoiler alert: No.

Recent Studies by Forbes and Morgan Stanley both agree that while this rule may work in a macro economics class, it will likely not be a factor for us this coming Fall. The reasoning lies with the complexity of the system. If the Fed raises the base rate, banks will not directly raise their rates on par. There is huge competition today in the debt markets. At last check there are 9 banks in Bedford alone not counting the two new branches about to open! That does not even get into the other lenders for commercial investment real estate, such as CMBS, life money and other players.

Additionally in order for property values to decline, we would have to go back to a golden rule of Econ 101, supply and demand. Quality investment and user assets are still at a premium. New construction, while increasing in New Hampshire, is not creating an oversupply of for sale assets on the market. IF the Fed raises rates and IF banks respond accordingly, the market is still tight with quality property and full of investors. The likelihood that rates will rise enough to chase people out of commercial real estate and into risk free returns such as CDs or bonds, is the same as Belichick and Yellen singing a duet in that same press conference.

Of course all of this speculation is both macro and in the near future. Interest rates take time to work through the system and get from Washington down to the local appraiser valuing an asset. Additionally, if rates do rise and banks respond accordingly, we may see some owner occupants leave the buying game and decide it is cheaper to lease. But that too takes time to work through the system. Until then we will monitor both Yellen and Belichick for signs of what the Fall will bring. 

Written by Chris Norwood, NAI Norwood Group, cnorwood@nainorwoodgroup.com.