Rate cuts were limited, but rising prices are still bringing some investors back to CRE

Commercial property owners got what they wanted in September in the form of a 50 basis point interest rate cut, courtesy of the Federal Reserve. But despite the long-awaited reduction in the base rate, long-term commercial borrowing rates are rising, holding back the market recovery.

Mortgage rates are rising, but commercial debt rates are holding steady, hovering around 4% at the end of October.

Analysts and experts are debating whether Federal Reserve Chairman Jerome Powell and the Federal Open Market Committee will cut rates at both of their final two meetings of the year.

Investors are divided on whether now is the time to get into the market, torn between market fundamentals such as cap rates, which have begun to decline in some asset classes, and rate cuts that have had no impact on commercial debt underwriting.

“We haven’t seen a change (in long-term rates) because people don’t really know where the economy is going,” said Holly MacDonald-Court, CEO of Miami-based mid-market lender KDM Financial. “There is no consensus that we will fall into a recession, which will lead to lower rates. I think we think the boom will continue.”

Some investors are not waiting for rate cuts to reach borrowers and are lining up deals now to prevent rising prices from the market recovery from eating into any savings on debt service.

National debt reached $244 billion in the third quarter, up 80% from the first half, according to Avison Young. CBRE announced this week that its investment sales revenue grew 22% in the third quarter compared with last year.

Yields on five- and 10-year Treasuries, the benchmark for similarly sized commercial loans, trended lower ahead of the Fed’s first rate cut as investors bet on what they expected to be an aggressive pace of relief through 2025.

But positive economic news following the Fed’s September meeting has investors wondering how quickly Chairman Jerome Powell and the Federal Open Market Committee will cut rates, forcing investors to put money back into long-term bonds.

“The (bond) market was very strong before the Fed cut,” said Nick Villa, an economist on Moody’s real estate team. “They may have been a little aggressive in recalibrating, but they are starting to find more consistency compared to where they were a year ago.”

The net effect has muted the impact of Fed rate cuts on long-term debt underwriting as the bond market seeks equilibrium after the longest yield curve inversion in history. These inversions occur when the yield on long-term debt is lower than what an investor can get from short-term debt, a historical indicator of an impending recession.

The 10-year Treasury yield was 4.2% on Thursday and has been above 4% for most of the year, compared with about 0.8% this time in 2020. On Tuesday, the five-year Treasury note traded at 4% and was priced above 3%. % from August 2022.

John Buran, CEO of New York-based Flushing Bank, said there is room for growth in the long-term bond market, which could add upward pressure on underwriting commercial real estate debt.

Recession fears have faded — the risk of a U.S. recession in October stands at 15%, according to Goldman Sachs — and expectations that the Fed is approaching its fabled “soft landing” could create additional tailwinds for the long-term debt market, Buran said.

“When people feel more confident, they want to take out loans. An increase in the number of potential borrowers flooding the market could lead to an increase in the price of money,” he said. “In the meantime, let’s hope the Fed continues to lower the short-term price of money.”

Many investors are still waiting for more cuts from the Fed, which analysts and executives expect will lead to a steady increase in deal flow over the next few years rather than a torrent of new activity.

Banks have yet to return to the commercial real estate market, in part because they face regulatory scrutiny over the health of their loan portfolios, a gap filled by private lenders whose investors demand higher premiums.

Although Flushing Bank’s transaction flow began to pick up in June, Buran said that growth still lags significantly behind the volume of transactions seen before the Fed began raising rates in March 2022.

“In dollar terms, this is really not the level of economic activity that we’re used to,” he said.

Macdonald Court has forced existing customers to abandon terms that would have taken their variable interest rates into the single digits as borrowers await deeper cuts. The Fed’s November and December meetings will give Powell the opportunity to bring more stability to the market, MacDonald-Court said.

“If the Fed continues to cut rates by 25 basis points per meeting fairly consistently, which they usually do, then that will eliminate some of the volatility in the market and we will have a horizon or floor on where we think rates will be. “, she said. “It gives everyone more confidence in the values ​​and more confidence in making transactions.”

McDonald-Court is among Fed watchers expecting a quarter-point rate cut at each of the Fed’s two remaining meetings this year, but that is far from a foregone conclusion. Moody’s forecast the Fed will cut rates by 25 basis points in November but keep rates unchanged in December, Villa said.

The Fed is pursuing monetary policy against the backdrop of a presidential election and wars in the Middle East and Europe, and Moody’s economists don’t expect long-term rates to begin to stabilize until the end of 2026.

“There is a significant reduction in prices planned over the next two years, but based on our forecast, we think we will have a neutral interest rate of around 3% in the first half of 2026,” he said. The 10-year bond rate settled at about 120 basis points above the benchmark rate.

The goal for investors today is to find the perfect time to enter the market by balancing the cost of debt and valuations, which are recovering in some sectors after falling in recent years.

There is consensus that the Fed has turned around and will cut rates, but debate continues about the pace of these cuts and where interest rates will eventually stabilize, and the recent rise in long-term bond yields reflects a market recalibration of when that rate relief will come.

“Everything just takes a little longer,” Villa said. “The economy continues to do well. He continues to defy expectations.”