What's Next for CRE In World Where the 10-Year Treasury is Around 5%

The 10-year US Treasuries rate hit 5% this week and that has commercial real estate investors rightfully concerned, according to a new news video by Marcus & Millichap.

Because even though the Fed has likely concluded its cycle of rate increases, the commercial real estate sector could still face significant interest rate headwinds, according to John Chang, its National Director of Research and Advisory Services.

He explains that most real estate lending is based on the 10-year Treasury, and over the last 90 days, the 10-year has climbed 120 basis points to the upper 4% range. It closed at 4.961 on Wednesday.

This, in turn, has pushed the single-family 30-year mortgage rate to the 8% range, driving home sales activity to its lowest level since 2010.

Additionally, commercial real estate lending rates have been on the rise, Chang said.

They now range between about 6.5% and 7.5%, depending on the property type, location, leverage, borrower strength, and a variety of other factors.

Chang said numerous forces are affecting long-term interest rates. First, the US Treasury has been issuing more debt.

In the past two quarters, the US Treasury has issued $1.9 trillion in Treasuries, which is triple the 10-year average issuance of $630 billion per six-month cycle.

This has been complicated by a reduction in demand for US Treasuries, Chang said, which leads me to the second driver of rising 10-year Treasury rates, reduced buy-side demand.

China has been downscaling its US Treasury holdings. Since the beginning of the year, China’s US Treasury balance has declined by about 7% from $867 billion to $805 billion, and they have not been buying as much as they have in the past.

Likewise, the Federal Reserve has reduced its acquisitions.

Beginning in June last year, the Federal Reserve began its quantitative tightening program.

Since then, the Fed’s holdings of US Treasuries have fallen by $843 billion, which is greater than China’s entire holding of US Treasuries.

“Granted, the Fed still holds two and a half trillion dollars more in Treasuries than they did prior to the pandemic, but as they bleed off their holdings, there are fewer Treasuries buyers, and that’s putting upward pressure on rates,” Chang said. “And rates could still push higher.”

He said if a federal budget resolution is not in place by Nov. 17, things “could be very difficult” as the US government could go through a shutdown.

If rates on Treasuries rise, then in turn, that would push up commercial real estate lending rates.

“But higher rates are not a foregone conclusion,” Chang said. “If the House of Representatives somehow averts a shutdown, that could help contain interest rate pressure.”

For the commercial real estate market, a rising 10-year Treasury could create additional headwinds, he said.

“The market is still in the process of recalibrating to the Fed’s rate hikes, and further rate increases could widen the buyer-seller expectation gap,” according to Chang. “Even if the Federal Reserve is done raising the overnight rate, the 10-year, upon which most commercial real estate lending is based, could continue to climb.”

Ultimately, Chang said, commercial real estate investors need to focus on the long-term outlook.

“Even if rates rise over the short term, it’s unlikely they’ll remain elevated over the long term,” Chang said. “Additionally, commercial real estate space demand should strengthen when the US enters the next growth cycle.”