By Exec Edge Editorial Staff
The Federal Reserve has increased interest rates 11 times between March 2022 and July 2023. In September, it decided to hold off on another increase, but many experts expect the hikes to eventually continue as the Fed tries to tamp down inflation that’s soared following the COVID-19 pandemic. Fundrise, a direct-to-investor asset manager known for its retail investment real estate platform, is monitoring these trends carefully, with an eye toward a potential recession and what that could mean for the real estate sector.
CEO Ben Miller argues that there’s solid historical evidence that our current conditions are setting the stage for a recession, but he also points out that in a market that’s moving in this direction, there are substantial opportunities for investors in real estate and other markets that play the long game and take a responsible approach to risk management.
To understand these opportunities, says Miller, we have to zoom out both in terms of a broader historical perspective on market trends and in terms of analyzing macroeconomic factors that could cause market shifts down the line. Given that the current market is anything but static, well-timed investments can be particularly successful. However, timing these investments and choosing the right assets based on long-term projections is no easy task.
“It’s difficult, I think, to do planning around something that’s this far away,” said Miller in an interview with Cardiff Garcia for the “Onward” podcast. “In some ways, people don’t know what to do with that and they’re almost likely to put it aside and say, ‘Well, it’s too far away for me to plan around.’ These big things you can only get ahead of, you can’t deal with it at the moment. You have to have done it beforehand. You have to take the hard preventative decisions that are not that fun in the short run.”
Interest Rates and Investment
In its midyear letter to investors, Fundrise was careful to lay out its position on the long-term impact of rising interest rates. Noting that some have pointed to the economy’s relative resilience to rate increases up to this point, the letter points out that, historically, the impact of this type of rate hike is felt downstream over a more extended period.
“The effects of rising rates have yet to really start impacting things. It’s not that the economy is strong so much as it just takes a long time for these things to play out,” reads the letter.
“The current period of seemingly little impact has created a false sense of confidence, and, like a dam that is structurally flawed, the pressure is building slowly, but most will not realize anything is wrong until that final tipping point when the pressure ultimately becomes too great, and the dam breaks.”
There’s historical evidence for this view, with a trend of recessions lagging behind peak interest rates. For example, the Fed raised interest rates from about 1% to 5% from 2004 to 2006, followed roughly 18 months later by the financial crisis of 2008. There was a similar lag in the early 1980s when the Federal Reserve raised rates by approximately 9% to combat inflation. The subsequent recession hit its low point 19 months after rates reached their highest point.
In March 2022, interest rates were below 1%. Nearly 18 months later, they now sit at approximately 5% to 6%. The question for investors, then, is what will our economy look like 18 months from now?
Fundrise’s Big-Picture Play
For real estate investors, answering that question involves not just looking at historical trends, but also at what’s unique about the current state of the market. In particular, this means analyzing the effects of an unprecedented global pandemic.
The shift to remote and hybrid work during the pandemic looks like it’s here to stay, with companies and developers forgoing investing in large, urban office space. This has left some areas of commercial real estate development in a precarious position. It’s also opened up opportunities for individuals to work in places that may not be as close to the office buildings of urban centers.
Amid this trend of more remote, suburban work, Fundrise has invested heavily in so-called “build-for-rent” housing in the Sunbelt. It expects a continuing need for remote workspaces and housing to continue to drive demand in the long term. In 2021, it secured financing from Goldman Sachs to fund a $300 million investment in its BFR business.
The outlook for this type of investment is simple to understand, Miller explained to The Real Deal.
“If you’re in your 30s, you have a kid, and you can work out of your house rather than an 800-square-foot apartment, you will,” said Miller.
On the commercial side, the company is focusing on investing in e-commerce warehouse properties as that industry continues to grow. Last year, it invested $128 million into acquiring warehouses for Saltbox, a business that provides coworking and warehousing space for up-and-coming e-commerce businesses.
The company is betting that, while many analysts are concerned about the long-term outlook for traditional office space, warehouses that enable e-commerce companies to ship products to customers’ homes will remain in high demand. Specifically, Saltbox is geared toward small businesses that may be able to increase their output and market reach using established warehousing infrastructure rather than running a business from home or a smaller space.
Finally, the company has expanded its investment in private credit through its Opportunistic Credit Fund, arguing that increased interest rates are straining real estate borrowers. For example, in 2020 a developer might have been able to secure $75 million at a 3% rate to finance 75% of a project. Now, that number would be closer to a $55 million loan at a 6% rate to finance 50% of a project.
This shift is creating a financing gap that needs to be filled by new capital. Miller maintains that there’s a “generational” opportunity for well-capitalized private credit investors to step in with gap loans at favorable terms, but that this investment window will likely be short-lived. A significant drop in inflation or an economic recession could stabilize and lower interest rates, closing the opportunity.
The Opportunistic Credit Fund returned a 13% annualized yield in its first quarter in 2023. This type of return speaks to the “great deleveraging” trend the fund has invested in through private credit. But it’s unclear how long this trend will continue, as it’s tied to higher interest rates.
Ultimately, the real estate and credit markets are dictated to a large extent by these rates and other macroeconomic trends. In its analysis of these trends, Fundrise has taken a longer-term, bearish position with the goal of shoring up its investments to minimize risk given a possible recession and taking the opportunity to find short-term wins only where they fit within a risk-averse strategy.
“I’m much more focused on protecting the downside than trying to capture that [short-term] upside,” Miller told Cardiff. “There are definitely exceptions, but the point I’m trying to make is that to win the ball game is the goal. And that is basically we’re just now talking about getting onto the field in the fall with the peak of interest rates as nine innings or nine months from there.”