CRE Industry Gets Lift With Fed’s Half-Point Rate Cut

The central bank’s hawkish policy under Fed Chairman Jerome Powell elevated borrowing costs to their highest levels in more than two decades in an effort to combat inflation, which had hovered around near-zero levels during the first two years of the pandemic. 

“This recalibration of our policy stance will help maintain the strength of the economy and the labor market, and will continue to enable further progress on inflation as we begin the process of moving toward a more neutral stance,” Powell said during a post-meeting press conference. “The U.S. economy is in a good place and our decision today is designed to keep it there.”

Powell said the median projection of Federal Open Market Committee participants estimates that the “appropriate” short-term interest rate will be 4.4 percent at the end of this year and 3.4 percent at the close of 2025 if “the economy evolves as expected.”

“In the medium term, whether today’s cut was 25 or 50 basis points isn’t especially material. What matters for investors is the clear signal that, based on current information, the Fed will likely cut by another 50 basis points this year and 100 basis points in 2025,”  said Sam Chandan, director of New York University’s Chen Institute for Global Real Estate Finance. “As recently as July, the Fed was signaling that a 50 basis point cut was not on the table. Today’s decision reflects that policymakers are more concerned about softening in the labor market than their official language suggests.” 

Lisa Pendergast, executive director of the CRE Finance Council, said that while it has been a tough two-and-a-half-year period for the CRE market in a higher interest rate environment — and on the heels of the COVID-19 pandemic — the industry is well positioned to thrive in the Fed’s new direction because of strong underwriting standards. She said the Fed kicking off its easing of rates could encourage borrowers to put more capital into their properties in anticipation of rates trending downward. 

“At the end of the day, the borrower given that giant delta between where their coupon is from the old loan and what the new one would look like will feel we are on that path to lower rates, so maybe it behooves me to pay down that loan a bit now and wait for things to stabilize over the near year and then refinance that money,” Pendergast said. “There is that opportunity to play the rate game once you get a better sense of how aggressive the Fed is going to be.”

Jay Neveloff, chair of law firm Kramer Levin’s real estate practice, said that while interest rates aren’t likely to go down to 2021 levels anytime soon, the Fed beginning the process of lowering borrowing costs will help jump-start transactions in late 2024 into next year. He added that even though many banks remain on the lending sidelines, other firms like family offices and private equity funds have stepped forward with more securitizations from loan portfolio sales as a way to spread out the risk.  

“I think 2025 is going to be gangbusters, and I think that the rest of this year is going to ramp up with activity,” Neveloff said. “What you don’t see is the big money-center banks or the big regional banks as active as they are, and to some extent the vacuum is being filled by private equity funds, by family offices and securitizations have picked up notwithstanding all the complications of how you deal with a troubled loan or a troubled asset when it is securitized.”

Bob Neighoff, portfolio manager of Mariner Investment Group’s commercial mortgage-backed securities strategy, said a positive factor in rate cuts will be the potential compression of capitalization rates that would increase property values and alleviate some stress in the CRE market by encouraging more investment activity. He noted that decreasing cap rates would increase the availability of refinancing opportunities or maturing loans, and result in higher valuations with real estate investment trusts.

Neighoff added that the Fed beginning a phase of rate cuts will aid more deals due to loosening interest rate cap requirements that had been mandated by lenders for floating-rate loans when there was uncertainty over how high rates might go.

“The costs of maintaining these interest rate caps soared, and borrowers either laid out millions to repurchase or they went into default on their loan by not purchasing it,” Neighoff said. “As the Fed telegraphs their future rate cuts, these interest rate caps become much less expensive, alleviating loan defaults and decreasing costs to borrowers.”

Eric Newell, chief financial officer of EagleBank, said he hoped the beginning of rate cuts will help bring more clarity to valuations, especially for its four office loans in the Washington, D.C., market. Nowell said elevated interest rates has resulted in higher cap rates and a wide disparity on valuations

Newell said a big challenge with higher interest rates has been borrowers unable in many instances to obtain permanent financing for completed construction projects, as regional banks are more cautious to take on more CRE balance sheet exposure. 

“Permanent financing might be an insurance company or a pension fund where they’re more willing to take a lot more duration on that loan that a community bank wouldn’t, but the reason that they haven’t moved that construction project off the balance sheet into permanent financing is because interest rates are so high,” Newell said. “With the expectation of the markets and the easing that they currently are contemplating, project sponsors could get exposure to the swap market and actually get much lower rates than even what today shows.” 

Holly MacDonald-Korth, CEO and president of KDM Financial, a middle-market CRE lender, said a full point cut by the end of 2024 would truly start to move the needle with underwriting. She stressed that knowing the rate cut cycle has begun is a lift in terms of getting borrowers and lenders “comfortable” returning to the market.

MacDonald-Korth said she hopes the kick-start of lower interest rates will propel more property sales that can aid better price discovery, noting that appraisals have varied by as much as 40 percent of late.

“We will often get one appraisal company and then get another company to give us a second opinion, but the appraisals will end up being so far apart that it almost feels like a valuation from a different decade,” MacDonald-Korth said. “I think that even a slight movement in interest rates is going to buffer everybody’s confidence that we’re moving back to normalcy.” 

Peter Merrigan, CEO and managing partner at Taurus Investment Holdings, said the Fed should have begun cutting rates far sooner, which would have avoided the potential of needing to implement a 50 bp cut that may cause worries of a weakening economy.

While Merrigan wishes the Fed had moved quicker, he said its signals in July of starting to pivot toward rate cuts led to more deal activity, with Taurus putting some assets on the market. He said more liquidity should be injected into the CRE market with investors pricing in a falling yield curve, but cautioned that it needs to get into the 2 percent range from the mid-3s it is at now.

“I think you’re going to have a lot of people in 2025 getting back into the marketplace,” Merrigan said. “But that is assuming that by the first quarter we’ve got 150 to 200 basis points of cuts, and I’m not sure we’re going to get there that fast.”

Eric Brody, founder of Anax Real Estate Partners, a CRE capital advisory firm, said a rate cut now is not enough to save distressed assets that have been saddled by rising interest rates the last couple years, and which still have a long way to go to ride out the storm. He hopes the start of bringing rates down marks an important step toward bringing more equity investors and limited partners back into the market.

Brody cautioned, though, that many investors are reluctant to truly enter the CRE market until after the results of the Nov. 5 presidential election are determined. The Fed’s next meeting will follow two days later, but it is possible a winner will not have been determined yet given how close the polls have been in the hotly contested race between Vice President Kamala Harris and former President Donald Trump.

“We need the rate cuts to start, and then we need another variable, which is the election and that the world doesn’t end, and then I think we’ll really start to see things really start to get interesting,” Brody said. 

David Greek, managing partner at Greek Real Estate Partners, said the Fed’s action is a “positive move” that will help reduce uncertainty while positioning CRE owners and investors to tackle deals on a long-term basis.

“Lower borrowing costs combined with a steady economic environment in the near- and mid-term will likely significantly increase investment activity, enabling industrial real estate developers to advance new facilities that have not been viable in the past two years based on the cost of financing,” Greek said. “At the same time, lower rates could enable property owners to reinvest in existing facilities through additions, expansions or upgrades.”

Andrew Coen can be reached at acoen@commercialobserver.com