US interest rate cut is good news for OrbVest investors
The US Federal Reserve's recent rate cut signals a promising investment opportunity in medical real estate, with lower capital costs and increased liquidity driving property values and investor returns.
*This content is brought to you by OrbVest
In mid-September, the US Federal Reserve (Fed) announced the first cut in the Federal Funds rate since 2020. Although it reduced its target rate by only 0.5 basis points (bps), economists widely expect this to be the first of several cuts going into 2025, as the Fed will try to strike a delicate balance between cooling inflation and triggering a recession.
The rate cut is good news for investors in any type of real estate because it has several implications.
- The first impact is the reduction in the cost of capital. Debt is used, especially in commercial real estate, to leverage a building's income to increase yield. A reduction in interest rates reduces the cost of owning the building, which not only increases the free cash that can be distributed to investors but also has a direct impact on the value of the building.
- The second impact is the increased liquidity in financial markets. Lenders that have withdrawn from the market because they cannot support their debt-to-asset ratios are risk-averse or don't want to price new loans when there is uncertainty is opening up lending again. Liquidity makes it easier to acquire buildings, which increases competition for good-quality buildings, which increases prices.
- The third impact involves timing. Although real estate entrepreneurs enter into multi-year financing agreements with lenders, those agreements terminate at the end of the fixed term, and cheap debt can become devastatingly more expensive. This presents an exciting opportunity to acquire buildings that, due to the prolonged high interest rate environment, are urgent sales as they now don't have access to affordable Debt. This presents a huge opportunity for Investment companies like OrbVest with strong balance sheets to acquire good buildings at significant discounts, recapitalize them, and create instant value for the investors.
An example of the above-mentioned situation is the acquisition of Red Oak Atrium, a building that OrbVest has under contract in Texas. The building is 100% Medical and is acquired at a 9% capitalization rate (this means that if you paid cash, you would earn 9% net income per annum), but it is plagued by vacancies and has been neglected. The building will be acquired for cash by OrbVest and its investors, stabilized, and will have new tenants placed there. Once rates drop to an acceptable level, the asset will be leveraged at 5% interest, while the net income (before debt) will be greater than 10% with new leases. This is why real estate entrepreneurs quickly make money in a bullish market.
A fall in interest rates impacts the cap rate, which is the asset value of a property divided by its net operating income. As interest rates fall, cap rates generally fall as well (although they are also influenced by other factors).
"We've been anticipating this rate cut for some time," OrbVest CEO Martin Freeman says. "While investors in our Accretiv portfolio of medical real estate have been partly shielded from the pain in the rest of the US real estate sector due to the quality of our healthcare tenants and buildings, we expect a massive investment opportunity in the next 12 months. That is particularly the case if there are several meaningful interest rate cuts.
"At this stage, we believe that medical real estate in the US is one of the most promising subsectors in an industry poised for a very profitable upturn in a falling interest rate environment."
Read also: