How Will the Drop in Interest Rate Impact CRE Pricing?

For the last three years, commercial real estate pricing had stalled, increasing at about 2.1% per year through April 2019, according to a new letter from UCLA Anderson Forecast and the UCLA Ziman Center for Real Estate. However, a recent reverse in interest rates could actually fuel commercial real estate pricing in the near term. The Fed is expected to reverse its quantitative tightening policy and decrease rates in July, and the 10-Year Treasury rate has dropped in response to fear of a recession. The event could shift cap rate and pricing expectations through the end of the year.

“Prices plateaued because interest rates were going up, but because of the recent drop in the 10-Year Treasury, prices might pick up in the near term. I am not as pessimistic as I was before,” David Shulman, senior economist for the Ziman Center and UCLA Anderson Forecast and the author of the recent letter The Good, The Bad and The Ugly, tells GlobeSt.com. “I was expecting the 10-Year Treasury to be well above 3% by now, but they are just a touch above 2%. That has taken some pressure off of cap rates on the pricing side. Prices for the past three years have leveled off, but they might accelerate from here. It won’t be by a whole lot, but it is less likely that you will get a price drop this year, which I thought we might see.”

Shulman isn’t surprised by the potential shift in Fed policy. He says that there had been some consensus that the Fed increased rates too quickly; however, he didn’t anticipate the response in the 10-Year Treasury. “I was surprised that they shifted that quickly, but what surprised me more was how the fear of recession entered into the 10-Year Treasury and the big drop in the loan rates,” he says. “I am one of 50 forecasters in the Wall Street Journal survey, and not one of the forecasters predicted interest rates to be this low at this time. There is a lot of divergence of opinion on Fed policy, but no one anticipated the drop in this yield from the 10-Year Treasury.”

While Shulman is “less pessimistic” on pricing, he still acknowledges that we are late in the cycle—and the fundamentals across asset classes reflect mature cycle dynamics. “On fundamentals, we are late in the cycle,” he says. “Vacancy rates are rising in apartments; vacancy rates are certainly rising in retail; and office never really recovered from the recession. Industrial is still on fire, and they will be good through the end of the year because of ecommerce.”