The Fed’s interest rate cut is unlikely to boost commercial real estate values, according to industry sources.
The Federal Reserve cut its key interest rate by a quarter percentage point on Wednesday to insure the U.S. economy against downside risks from weak global growth and trade policy uncertainty. This is the first rate cut of Fed chairman Jerome Powell’s tenure, and the first easing since the end of 2008, when central bankers lowered rates to near zero levels.
The U.S. economy remains healthy as indicated by low unemployment, wage gains, consumer sentiment and recent GDP growth. But trade uncertainty, corporate earnings, a manufacturing slowdown and issues with Brexit and Europe prompted the Federal Reserve to act now to sustain economic expansion.
Some say the interest rate cut will provide momentum for the commercial real estate industry. Combined with the relative attractiveness of U.S. real estate, lower hedging costs should support more international capital flows into U.S. property markets. As a result, there may be some incremental cap rate compression in some markets and property types as lower interest rates reduce upward pressure on cap rates, according to a report from real estate services firm CBRE.
But the move to cushion the economy will likely have an overall negligible effect on the commercial real estate industry, according to several industry sources. Heidi Learner, chief economist at real estate services firm Savills, says the rate cut is unlikely to boost commercial real estate values because reduction in rates does not necessarily stimulate investor demand if the demand is not already there.
“I don’t see [Wednesday’s] cuts having much of an appreciable effect on commercial real estate largely because we have had already a fairly dramatic decline in financing rates and we haven’t seen much of a reaction either in the way of loan growth or a real compression of cap rates,” says Learner. “So, I don’t think the 25-basis-point cut just in the policy rate is really going to pass through and provide much impetus to commercial real estate.”
Prior to Wednesday’s interest rate cut, yields on 10-year Treasuries have plummeted 75 basis points since the end of 2018, Lerner notes. Despite the decline, there has been little effect on cap rates. The median cap rate on office properties in U.S. central business districts (CBD) was 5.2 percent in the second quarter of 2018, 5.1 percent in the fourth quarter of 2018, and 5.0 percent in quarter two of 2019. If cap rates have not dropped in tandem with the decrease in Treasury rates so far, Learner says it’s unclear that an actual rate cut by the Fed will be the catalyst for sudden cap rate compression.
“It’s more of an emotional sentiment [the interest rate cut] is going to have than anything else. Reducing the rate and increasing the access to capital is always a positive for the market,” says Stuart Showers, Houston-based vice president of research with real estate services firm Transwestern. “Is it going to be a turning point in increased transaction activity? No, not at all.”
Learner says the interest rate cuts will likely not alter “any investment that had been pondered before [Wednesday’s] move” and that the commercial real estate industry should not see a “dramatic increase in activity” because of the cut.
With regards to the future, the Fed seemed to step back from signaling potential further rate cuts in September, according to MarketWatch. CNBC reports that potential for further rate cuts was not clear enough and markets viewed Powell’s comments regarding future cuts as confusing. The feeling is that there is at least one more rate cut possible this year if economic conditions warrant another move.
“I view [interest rate cuts] as a positive, but with a cautionary note. Cautionary note is, when the central bank cuts rates, it’s because they may be seeing dark clouds on the horizon or some slowdown coming that they’re getting prepared for,” says David Pascale, senior vice president with George Smith Partners, a commercial real estate capital markets advisor. “So, I think owners should be aware of that and not take this rate cut at its nominal value and say, ‘capital just got cheaper, I’m going to be more aggressive.’ I think owners should be looking at the reasons behind the rate cut. These macroeconomic issues can weigh on commercial real estate growth.”
FAQs
You'll get a lower APY on your savings.
The flipside of a Fed rate reduction is that "while borrowing will become less expensive, those lower interest rates will hurt savers," said CNBC.
How do interest rates affect CRE? ›
Decreasing Property Values
Investors have a specific yield or cash on cash return target that they need to hit when they're investing in commercial properties. If interest rates increase, the only other lever that can be pulled for them to hit those returns is a decrease in property values.
What do interest rate cuts mean for the stock market? ›
Moreover, a decrease in interest rates will prompt investors to move money from the bond market to the equity market in hopes of greater opportunities. The influx of new capital instead can cause the stock markets to rise.
What happens when the central bank cuts interest rates? ›
This will cool the economy, reduce inflation expectations and bring inflation down. If inflation is too low, we can lower interest rates and make credit cheaper to boost investment and spending, which raises inflation. In recent years, inflation was too high. Prices increased a lot, especially for energy and food.
Are rate cuts bullish? ›
JULIE: Conventional wisdom still holds that cutting rates is bullish, while actions that would delay cuts are considered bearish. Rate cuts favorably impact consumer confidence.
What are the effects of cutting interest rates? ›
Interest rates have a direct effect on consumer behavior, impacting several facets of everyday life. When rates go down, borrowing becomes cheaper, making large purchases on credit more affordable, such as home mortgages, auto loans, and credit card expenses.
What is the outlook for commercial real estate? ›
The commercial real estate outlook for the second half of 2024 is largely positive—multifamily continues to perform, as do industrial and retail. But challenges could lie ahead. The higher interest rate environment appears to be here to stay, and office vacancies continue to climb.
What is the outlook for the commercial real estate market in 2024? ›
Retail Properties
With fewer new construction deliveries, the fundamentals of this sector will remain solid in 2024. When new supply is constrained, it can lead to tighter market conditions, potentially supporting rental rates and occupancy levels, key components of the commercial real estate sector.
Why is commercial real estate in trouble? ›
Many commercial loans were made during the recent period of historically low interest rates. So, they now face a double whammy. The persistence of working from home has driven falling asset values due to declining demand for office space, and building owners also significantly higher interest rates when refinancing.
Who benefits from higher interest rates? ›
With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.
In the 12-months after the US Federal Reserve (Fed) starts cutting interest rates, the average return from US stocks has been 11% ahead of inflation. Stocks have also outperformed government bonds by 6% and corporate bonds by 5%, on average. Cash has been left even further in their wake.
Who benefits when yields or interest rates are low? ›
When yields or interest rates are low, it typically benefits borrowers more than lender...
What does the interest rate cut mean? ›
If your mortgage is such that your payments go up and down in response to your lender's prime rate, your payments may automatically decrease. Otherwise, a lower rate will mean more of your money will go towards the principal amount of your mortgage.
What does cutting interest rates do to inflation? ›
Decreasing the policy interest rate can stimulate economic activity and cause inflation to rise. Lower interest rates encourage people to spend more and save less.
What is the Fed rate cut expectations for 2024? ›
We project the federal-funds rate target range to fall from 5.25% to 5.50% currently to 4.75%-5.00% at the end of 2024, 3.00%-3.25% at the end of 2025, and 1.75%-2.00% by the end of 2026, after which the Fed will be done cutting.
Do mortgage rates go down when the Fed cuts rates? ›
Some experts believe mortgage rates could fall 0.25 to 0.75 % when and if the Fed cuts rates for the first time in 2024. In fact, some experts believe the reason why mortgage rates have been failing recently is because the market is anticipating a rate cut.
What happens when the Fed changes interest rates? ›
The Fed's decisions influence where banks and other lenders set interest rates. Higher Fed interest rates translate to more expensive borrowing costs to finance everything from a car and a home to your purchases on a credit card.
How much interest rate will be cut in 2024? ›
Key Takeaways: The Bank of Canada (BoC) announced on July 24, 2024 that it would be cutting its overnight lending rate to 4.5%, following a similar .25% cut in June. TD Economics believes the BoC is now in a “phase of rate cuts” and that the central bank will gradually reduce rates throughout 2024 and into 2025.
How many rate cuts are expected in 2024? ›
To combat inflation, the rate was raised 11 times between March 2022 and July 2023. Inflation has receded, but the Fed has signaled it wants more positive data before pulling the trigger. In March 2024, the central bank predicted three quarter-point cuts by the end of the year.
