CRE Gets Ready for Imminent Rate Cut

The start of interest rate cuts is imminent, according to remarks made Friday by Federal Reserve Chair Jerome Powell, who expressed confidence that inflation is within reach of the U.S. central bank’s 2 percent target.

“The time has come for policy to adjust,” Powell said in a highly anticipated speech to the Kansas City Fed’s annual economic conference in Jackson Hole, Wyo. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”

Analysts and financial markets had already widely expected the Fed to deliver its first rate cut at the Sept. 17-18 policy meeting.

There is “ample room” for the Fed to reduce borrowing costs to cushion the labor market, with its policy rate currently in the 5.25 percent to 5.50 percent range, Powell suggested.

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Commercial real estate participants and observers commented on the forthcoming rate cuts.

Perhaps turning a corner

Pierre Debbas, co-founder of Romer Debbas, told Commercial Property Executive that rate cuts are mandatory to prevent a wave of distress in certain asset classes, such as office, and as a hedge against additional regional banks collapsing.

“The extend and pretend has been going on for over four years, and we are walking a fine line between turning a corner and a catastrophe in the industry,” Debbas said.

“Transaction activity across the board is at its lowest level in years. Real estate is the backbone of our GDP; we will not see any uptick in activity until rates have come down as valuations and cash flow were predicated on the low cost of debt and do not substantiate a debt service of 3x+ that was the norm a few years ago.”

Between last year and this year, well over a trillion dollars of commercial real estate debt is approaching maturity, and “lowing rates is the only way these properties can actually refinance and stabilize,” he said.

Increased capital flows, transaction activity

Karlin Conklin, Investors Management Group principal, co-president, & COO, told CPE that falling interest rates will revitalize commercial real estate.

“High cap rates, driven by elevated interest rates, have crushed property values,” Conklin said. “Expensive debt service is cutting into net income. As rates drop, all these dynamics shift. I expect increased capital flow, cap rate compression, and a rise in property values and trading volume. Yields on multifamily become especially compelling again.”

Anita Verma-Lallian, founder & CEO, Arizona Land Consulting, told CPE in the past couple of weeks, she’s noticed an uptick in calls and offers from developers anticipating a rate reduction.

“As soon as rates come down, we expect to see an increase in commercial real estate activity as builders and developers who were previously waiting on the sidelines move forward with construction,” Verma-Lallian said.

“The increase in development will be positive for the national economy, creating more jobs and an inventory of all asset types. Currently, the supply is low, causing pressure and pricing increases that should be alleviated and leveled out with new development to meet demand.”

Uncertainty will ease

Jeff Warwick, CEO of CCI Real Estate, told CPE the Fed’s highly anticipated near-term rate reversal will spawn several actions and reactions within commercial real estate.

“First, uncertainty will ease, pending transactions will find their price, and volume will slowly tick up,” Warwick said. “Second, loan runoff will accelerate, and lenders will initiate advance calling efforts to seed the inevitable 2025 earnings pressure. Third, protective advances, capital calls and sponsor illiquidity will continue to plague certain product sectors and certain markets and look more like a traditional commercial real estate cycle; the over-extended will serve as short-term fuel for the liquid.”

He said that losses embedded in the system will occur, even as capital costs revert to the (higher than historically average) mean.

“In the long term, for commercial real estate, residential shortage and working overage will continue to be resolved, as ‘living-at-work’ has now become ‘working-from-home.’”

A positive for the cost of borrowing

Julie Hyson, Americas Portfolio Clients, Services and Industries lead, Project and Development Services, JLL, told CPE, “A rate cut would positively impact the cost of borrowing, making construction financing more attainable for owners and developers, releasing more capital spending, and meaning more projects moving forward,” Hyson said. “However, it is too early to know the specific impacts, as the extent, speed and details of cuts have not been announced.”

Hyson said the impact in the near term may be the opposite of what is wanted; owners and developers may turn to wait if they expect further cuts to be “just around the corner.”

“However, the construction industry is resilient, and current workloads will continue to bridge.”

Help for inadequate housing supply

Doug Ressler, manager, Business Intelligence, Yardi, told CPE that more important is how the key issue of housing supply will be addressed.

“The broader problem is that people believe the lack of lower interest rates is the root cause of the inadequate housing supply,” Ressler said. “However, once lower interest rates begin to occur, we will discover that that’s not even the real culprit.”

He said the problem is a lack of adequate stock based on land use patterns across the U.S. In the multifamily sector, rents are flattening or declining in many markets while operating expenses are skyrocketing, Ressler said.

“Rents are falling in areas where local municipalities encouraged housing supply and low capital costs,” he added. “The significant increase in rents in 2021 and 2022 was driven by the migration of people driven by COVID-19 and the changes to where people worked and lived.”