The fulfillment of anticipation is almost here. The likely expectation is that the Federal Reserve’s Federal Open Market Committee will cut interest rates. The probability of a 25-basis-point cut according to 30-day fed funds futures pricing via CME FedWatch is 69%, with a 31% expectation of a 50-basis-point cut.
Even as many in CRE have looked to rate cuts as a bailout from the difficulty of refinancing, it’s unclear how much favorability they can expect and how quickly.
First, the amount of any cut will be small, at least to start. FedWatch shows a 77.5% chance of a total cut between 100 and 125 basis points by the December 12, 2024, meeting. Is that enough of a rescue/? It would depend in part on how much of a spread lenders decide to maintain. Clark Finney, vice president and director of Matthews Real Estate Investment Services, wrote that the ultimate effects are unclear because the “impact on asset values is complex.”
Lenders might not do point-for-point matches in most conventional deals, particularly if Treasury indexes are used as the basis for pricing coupons. Finney noted that often CRE deals price in expectations of rate cuts or increases far in advance. As an example, the 10-year Treasury yield went from 4.09% at the end of July to 3.65% on Tuesday, Sept. 10.
There is unlikely to be a quick return, if it ever happens, to ultra-low rates. The country doesn’t face the type of “extreme economic conditions” of the Global Financial Crisis or the Covid-19 pandemic that triggered the quick slashing of rates to near zero levels.
Even if borrowing rates decrease immediately — and that isn’t a given — cap rates typically take six to nine months to reflect a correction, Finney says. The delay and opacity offer investors a chance to act before the market has digested what the Fed has done. He offers the example of someone finding they can purchase a property with a 6.5% cap rate while financing costs are 5.5%.
Ryan Severino, chief economist and head of US research at BGO, told GlobeSt.com that the CRE equity market’s short-term outlook should be investment volumes and valuations should slowly increase. Cap rates should “compress more meaningfully” and total returns should “gradually improve” as the short and long ends of the yield curve move downward.
As for the short-term credit market outlook, Severino thinks debt origination volume will slowly increase as the cost of debt slowly decreases. Loan performance will depend on the property type, with office facing ongoing “structural challenges” and multifamily challenged by “variable-rate debt that repriced as interest rates increased.”