CRE in a Period of Normalization Amid Fed Rate Cut

To quote Cat Stevens or Rod Stewart, depending on your preference, the first cut is probably the deepest. Kevin Fagan, head of CRE economic analysis at Moody’s Analytics, said of the Fed’s large September interest rate cut. During an interview with Yahoo Finance, Fagan said he expects an additional 25 bps cut over the next few months as the Fed remains cautious on strength in the labor market.

The CRE market is likely to react very slowly to the rate cut, said Fagan. And while inflation remains a concern, what really matters to commercial real estate is the certainty that is emerging around rates.

“We’re actually starting to see transaction volume starting to tick up,” noted Fagan. Year-over-year transaction volume went positive for the first time and last quarter marked the second quarter in a row of positive lending volume, he said.

“The numbers aren’t anything to get excited about but the momentum is going in the right direction and stability around rates in particular will help that.”

Fagan said CRE broadly is in a period of normalization, with some negative indicators and some positive indicators over the past year. Tenancy, rents and vacancies have gone in the wrong direction overall, he said, but prices have been relatively stable.

Regionally, the Sun Belt is still dealing with the fallout of a superheated CRE market characterized by a large supply of new construction and is now correcting. Meanwhile, performance is picking up in the Snowbelt, including the Northeast and northern Midwest states, he said.

Office attendance remains well below pre-pandemic levels, but it did improve significantly over the past year. The nation appears to be settling into a hybrid approach for professional services companies.

“What’s really important for us is to figure out what kind of space tenants are going to take per employee now in this hybrid work environment,” said Fagan. “It takes a long time for these leases to roll over … we really are probably about two years from having a real handle on what normal means for the office.”

Reformatting commercial buildings as residential buildings has become a trend, said Fagan, but the success of these types of projects depends on the government helping, or more precisely, getting out of the way and letting it happen. Projects can quickly become challenging for developers over details like inoperable windows in an office that must be operable for a residential property. These types of roadblocks can make it hard to earn a profit.

“It’s probably going to be a fringe trend unless governments really start stepping in,” Fagan said.