Interest Rates in 2025: Where Are They Headed?

In life, we’re told the only guarantees are death and taxes. While not nearly as morbid nor pessimistic, in commercial real estate, the only promise made by the market to either owners or investors is that interest rates will influence their bottom lines. 

And interest rates in America are anything but a simple subject.  

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As we enter 2025, with Federal Reserve Chairman Jerome Powell having mercifully initiated  three rounds of cuts to the the short-term benchmark federal funds rate —  which now sits between 4.25 and 4.5 percent, after remaining frozen in place at 5.25 and 5.5 percent from July 2023 to September 2024 — the belief among CRE professionals is that the worst of inflation is now behind us, and that interest rates no longer need to remain so high. 

The oracles inside the Eccles Building appear to be listening. In his Dec. 18 remarks, Powell signaled at least two rate cuts are in store in 2025, and that the average projection of Fed committee members indicates a target federal funds rate of 3.9 percent by late 2025, with projections it could fall as low as 3.4 percent by the end of 2026. 

“The Fed’s job is to carefully control inflation, while taking employment into account, and employment is very strong nationally, so they seem to have been able to have gotten inflation under control,” said Jed Resnick, CEO of of Douglaston Development, a New York City development firm, who noted the annual inflation rate cooled from a 41-year high of 9.1 percent in June 2022 to just under 3 percent by December 2024. 

“I think they’ve done a good job of stewarding the economy back from a somewhat overheated state to a more manageable level of prices,” Resnick added. “They pulled off the soft landing [of avoiding a recession], which everyone thought they should do.”

Not everyone is happy, however. A Dec. 16 editorial from the Wall Street Journal asked why Powell would cut rates a full percentage point when the price level of goods over 12 months increased by 2.7 percent, (technically 3.3 percent, excluding food and energy costs) and the producer price index (PPI) reached 0.4 percent month-over-month in November, its highest rate since June. 

George Tietjen, managing director at Sentinel Real Estate, a $9 billion CRE equity fund, suggested that there appeared to be dissension among the Fed’s Board of Governors in their recent meeting, with three nonvoting members implying they didn’t want a third straight interest rate cut.

“I think they’re realizing they’ve done a good job to get the bad part of inflation under control, but they’re really struggling with that last mile — getting [the annual inflation rate] to that 2 percent target,” said Tietjen. “And I also noticed they pushed the potential date for hitting that target out to 2026. It’s challenging — you wonder why they [cut] with readings of inflation percolating higher?”

Conventional wisdom suggests cutting the short-term benchmark rate would indicate inflation is slowly dissipating, thus bringing commercial real estate finance into a place of comfort to lend, refinance, and build under the belief that interest rates — both short term and long term — will remain low for the foreseeable future. 

If only finance was so conventional. 

“It’s not that the federal funds rate is the most material number for the commercial real estate industry, but what the industry has responded to is we’re now in a new phase in the monetary policy cycle,” said Sam Chandan, founding director of New York University’s Stern Chao-Han Chen Institute for Global Real Estate Finance. “We moved past that peak in the influence that monetary policy has on our cost of capital in the industry, but what’s critical here is longer-term rates have not gone down — in many cases they’ve gone up.”

The relationship between interest rates and the wider commercial real estate economy is deeply complex. There are inverse correlations between yields and prices on both short- and long-term bonds, different rates for separate timelines, and securities markets that both influence and react to not one, not two, but three separate interest rates impacting property valuations and lending conditions. 

Case in point: the 10-Year Treasury, the benchmark long-term interest rate most closely correlated to CRE investment and lending conditions due to the standard 10-year horizon of most property loans.

After sitting below 2 percent from July 2019 to March 2022, the 10-year Treasury began an unrelenting climb over the next 18 months once Powell began raising his short-term rate, cresting at 5 percent on Oct. 22, 2023, its highest level in 16 years. While correlation does not equal causation, the rise in the 10-year Treasury occurred in almost perfect symmetry with inflation reaching its highest level in four decades beginning in late 2021. 

Again, conventional wisdom would suggest that once inflation cooled, and the Fed cut its short-term federal funds rate, the 10-year Treasury would also decline. Instead, the 10-year has risen from 3.6 percent prior to Powell’s first cut on Sept. 18 to 4.6 percent on Dec. 27, nine days after his third cut. 

“The federal funds rate is a short-term rate, while the 10-year rate and the 30-year rate are long-term rates, and those rates are based upon what people feel about future expectations. And I think right now there’s terrible uncertainty as to what the future will be as far as inflation,” said Stuart Boesky, CEO of Pembrook Capital Management, a CRE investment firm. “We have a new administration, and their entire economic program in many people’s view is inflationary: tariffs, lowering taxes, raising the deficit — it’s all inflationary.” 

So, if up is down, despite down being up, and inflation remains a threat, even though Powell’s actions indicate it’s now at bay … What on earth is going on with interest rates?

A strange relationship

The federal funds rate, the benchmark short-term rate, is the Federal Reserve’s main tool for affecting monetary policy and adjusting overall economic activity. When the economy is overheated and inflation is high, the Fed raises the target range of overnight loans set between banks across the capital markets system, as the federal funds rate is technically an interbank lending rate. 

“When we say, ‘the Fed cuts rates,’ they’re not actually cutting rates. They are cutting what they are targeting the rate to be. The rate is set by the overnight loans between banks in the market,” explained Niree Kodaverdian, research manager at Beacon Economics. “Essentially, there’s a very subtle relationship. The Fed uses open market operations to change the supply of money to achieve the target they want, and they do this largely by buying and selling Treasurys, changing required reserve ratios, and other open market operations.”

The funds rate is the benchmark that governs all floating-rate debt, and the big market index rate that all CRE loans rely on is SOFR — the secured overnight financing rate — a short-term interest rate which largely mirrors that funds rate. For instance, SOFR today sits at 4.46 percent, nearly identical to the Fed’s 4.25 to 4.5 percent target range. 

When the Fed increases its short-term rate, that in turn increases the rates at which lenders and and investors fix their loans, which makes borrowing across the economy more expensive, therefore reducing overall economic activity. If the economy is overheating, the last thing the Fed wants is more construction projects. 

“The fundamental impact [of rate hikes] is that it increases the cost of construction. Construction loans are all done on a floating-rate basis, and a higher interest rate means higher costs,” said Resnick. “A difference of one or two points in floating-rate construction loans won’t make a bad deal, but, on the margin, it definitely makes it more difficult to source new opportunities for new business.”  

Yet, even as both SOFR and the funds rate have dropped precipitously in the last few months, other critical interest rates, like the long-term 30-year mortgage rate, the two-year Treasury yield and the 10-Year Treasury yield, have remained high. It’s a phenomenon that confuses many Americans, particularly homeowners, and even some investors. 

“What most consumers don’t realize when they hear ‘the Fed drops rates’ is they think the mortgage rates will be dropping, but they don’t realize mortgage rates are correlated to the 10-year Treasury rather than the federal funds rate,” explained Katie Hubbard, executive vice president of capital markets at Walton Global, an asset manager and investor. “People are waiting on the sidelines, and then they hear rates are dropping — and they didn’t, they actually spiked — and it’s caused potential homebuyers to remain on the sidelines.”

During COVID-19, the 30-year mortgage fell to an all-time low of 2.67 percent in December 2020, but reached a 23-year peak of 7.76 percent in November 2023, according to data from the Federal Reserve Board of St. Louis. Even though that 30-year mortgage rate dropped to 6.09 percent in September 2024, it immediately rose to 6.85 percent by late December, following the announcement of three cuts to the federal funds rate.

Hubbard added that “the magic rate” for people to get off the sidelines for home purchases is 5.5 percent, and that her firm doesn’t predict the 30-year mortgage to fall below 6 percent until well past 2026, largely due to expectations that inflation will remain high, causing long-term rates to remain elevated. 

“When you look at interest rates, there are short-term interest rates and long-term interest rates,” said Jillian Mariutti, senior director at JLL Capital Markets. “SOFR moves in lockstep with the federal funds rate, and that’s been moving down as the Fed cuts, whereas the 30-year mortgage is more closely tied to 10-Year Treasury.”

And there you have it: the 10-Year Treasury, perhaps the most important interest rate in America, and certainly the most paradoxical. It’s an interest rate whose apparent simplicity as a bond is belied by the numerous questions it generates. How does a decade-long government security impact housing prices today? What is the relationship between its low price and high yield? And why is the 10-year Treasury now rising if inflation is supposedly cooling alongside a steadily decreasing Federal Funds rate? 

The ultimate interest rate 

On the surface, the 10-Year Treasury sounds simple; after all, it’s a bond. But diving a little deeper into the pool of government-backed securities, we find benchmark financial products that backstop the most liquid bond market in the world, one traded every second of every day. 

Treasurys — either T-bills, T-notes or T-bonds — are U.S. bonds that can mature at anywhere from 30 days to 30 years. These short- and long-term bonds are the foundation of the U.S. financial system, as they are guaranteed by the full faith and credit of the government (and its military). There are two types of 10-year Treasurys: zero coupon bonds — an investor purchases it for X amount and receives X amount after 10 years — and coupon interest bonds — an investor purchases it for X amount and receives an interest payment every month or every quarter over a 10-year period. 

The key to understanding Treasurys (and yes, the plural is Treasurys, not Treasuries), and by extension the current predicament in the bond market for commercial real estate, is the inverse relationship to prices and yields on the bonds. 

The yield on the 10-year Treasury is determined by the extent to which investors are buying and selling either newly issued or existing 10-year bonds already out there. From the point of view of investors, what they really care about is yield. Some want money coming in every month, while others care about only total return at maturity, but both types of investors expect their securities to be worth more at the end than what they paid at the beginning. However, due to the 10-year duration of this benchmark Treasury, the value of the security changes as the interest rates on different types of securities fluctuate around it. 

“If the interest rate on a 10-year Treasury is X, and the rate on some other bond goes up, I’m not going to want that 10-year Treasury unless its price goes down, which is the same thing as saying its yield goes up,” explained Brad Case, chief economist for Middleburg, a real estate investment firm. “In general, if I have a 10-year Treasury, and interest rates go up, that means the value of my existing Treasury goes down — people don’t want it because they can get another Treasury at a higher interest rate.”

This logic is a large reason Silicon Valley Bank failed in March 2023. The bank and other regionals had stuffed their balance sheet with long-term Treasurys under the assumption that inflation was a thing of the past and the Fed would keep interest rates low forever. 

And this is why it’s so critical to understanding the negative sentiment fostered in CRE circles when the yield on 10-year Treasurys jumps from less than 1 percent, as it stood in mid-2020, to nearly 5 percent by late 2023, after dependably hovering below 3 percent for the entire 2010s. 

“The 10-year Treasury plays into our underwriting quite a bit,” said Brandon Honey, head of capital markets at investment manager Blue Vista. “Not only do you need to pay attention to U.S. Treasurys when underwriting debt, but you have to look at it to figure out how it plays into exit cap rates. As the Treasury continues to be volatile, it’s difficult to figure out where the exit cap rate should be.”

Honey said the last three years of volatility around the 10-year Treasury — with yields jumping up and down from 3 to 5 percent, and back again like an overactive kangaroo — has impacted CRE underwriting and investment opportunities across all asset classes. 

“It’s made us more cautious about being aggressive with our capital,” he said. “You really don’t know where the 10-year will go, you can only do so much with the information you have, and the more volatile the market seems, the more conservative you want to be with the refinance assumptions model and exit cap rate assumptions.”

The volatility of Treasury yields has been particularly difficult for multifamily owners and investors, and even individual homeowners. 

The 10-year is the fixed-rate financing that’s offered by Fannie Mae and Freddie Mac for multifamily apartments. Traditionally, the 10-year is indexed off what real estate is priced at due to the standard 10-year nature of most real estate loans and because agency securities trade at a spread to the existing 10-year Treasury yield. 

“Every time the 10-year Treasury goes down, Fannie and Freddie rates go down. And every time Freddie and Fannie rates go down, it means you can finance apartments cheaper. And if you can finance them cheaper, they can produce higher cash flow. And if they can produce higher cash flow, that means people pay more for that property,” explained Boesky. 

Considering that cap rates are a function of net operating income divided by asset value, cap rates therefore compress when money is cheaper. That means lower interest rates in the bond market make alternative assets like securities less attractive, driving demand for higher-yielding investments like physical real estate.  

“When [bond] rates were almost zero, people were paying up big time, and cap rates were very tight because alternative fixed-rate investments produced almost no return,” explained Boesky. “When rates are low, two things happen: You can lever property to produce more cash flow, which is valuable, and your alternatives to that piece of property — the risk-free return — are less attractive, so people pay more for your property.” 

This is where the invidious nexus of inflation, Treasury yields, and real estate values comes together. As inflation has emerged, the 10-year Treasury has crested close to 5 percent, reversing a decade of cap rate compression and harming asset values, with investors running away from long-term bonds that will be worth less over time amid inflationary expectations, in turn keeping the rate “higher for longer.” 

“If you think inflation will be higher, then you don’t want the 10-year Treasury because it doesn’t protect against inflation, so there’s less demand, its price goes down, and that means its yield goes up,” explained Hubbard. “If yields go up, it means people are more concerned about inflation.”

Hubbard emphasized that inflation is the key reason the 10-year’s yield has stayed so high since 2022, as its yield is merely a function of what the market is willing to pay for longer-term debt and to entice investors over a decade-long period, when who knows when and where inflation will appear and reappear. 

“They need to be rewarded for that risk. The spread needs to compensate investors,” she said. Right now, “It’s uninviting, so investors are earning a higher premium for investing in longer-term yields rather than shorter-term yields. It’s the market demanding higher premiums for uncertainty.”

Middleburg’s Case noted that in any investment it’s all about risk and return, and the return on a bond is the yield, while the risk on a bond has to do with how its value will fluctuate. To wit, the 10-year Treasury has always seen more fluctuation because it’s dealing with assumptions about the economy and inflation over a decade — much like a physical real estate asset. 

And, bringing it all home, those concerns about inflation caused Jerome Powell to raise the short-term federal funds rate, indicating a long-term battle over higher prices is now on, which in turn brought the 10-year Treasury higher — conditions which remain ever present even after Powell’s recent rate cuts have indicated apparent victory. 

“If the federal funds rate is cut because we’re going into recession, then people won’t be worried about inflation, and the 10-year Treasury yield comes down. But if the federal funds rate gets cut even at a time when the economy is strong, then people will be concerned about inflation, and they will push the yield up because they don’t want to own those Treasurys unless they are inflation protected,” explained Case. “The reaction [to this bond] tells us whether people are concerned about either a recession or inflation.”

And since the re-election of Donald J. Trump in November, there’s no doubt the market is increasingly concerned about inflation. 

The Trump bump?

Having won all seven swing states, the Electoral College and the popular vote, Trump returns to office with a clear (if slim) mandate. The once and future president has indicated he will look to cut taxes, raise tariffs, and deport millions of immigrants — policies many believe will break, not maintain, a fragile truce the Fed has made with inflation. 

“There’s increasing concern at the Federal Reserve that some of the policy priorities of the incoming administration, including tariffs on major trading partners and a potentially dramatic shift in labor market dynamics following new immigration policies, could introduce both one-time price shocks, but also stoke inflationary pressures,” said NYU’s Chandan.

Trump’s promise to deport millions of undocumented immigrants — many of whom are already ingrained into the economy — could depress the CRE industry due to the intertwined natures of labor and real estate, according to TJ Parker, senior vice president of data analytics at Bell Partners, a multifamily investment firm.  

“It might dissuade some employers from hiring immigrant groups. Construction, retail, leisure and hospitality — all these sectors benefit from immigration labor,” said Parker. “When there’s lower labor in these sectors, you’ll see corresponding wage growth tick up because there’s ample demand.” 

Parker added that Trump’s proposed tax cuts, both at the individual and the corporate levels, are inflationary in nature due to the connection between GDP growth and the 10-year Treasury. Supercharted economic growth increased Treasury yields leading up to the dot.com crash in the early 2000s and the Global Financial Crisis between 2007 and 2009. 

“The 10-year is the economy-wide cost of borrowing. It typically matches the nominal GDP growth rate — which is nothing but the real economic growth rate plus 2 percent inflation — so that’s how we get to 4 percent,” explained Parker. “Since 2022, economic growth has averaged 2.5 percent and the 10-year yield has averaged 3.7 percent over that same time period. So when we see higher economic growth, you see an uptick in the 10-year, and you’ve seen this pattern before.”

Then there are the tariffs. Trump has proposed 25 percent tariffs on imports from Canada and Mexico and 60 percent tariffs on goods from China. Parker also defined the tariffs as inflationary, while Ralph Esposito, national president of Suffolk Construction and former chair of the New York Building Congress, told CO that Trump’s tariffs could actually boost the U.S. economy by 7 percent and create 10 million jobs. 

“Higher tariffs on goods from Mexico, Canada and China could increase some construction costs in the short term, but could also pave the way for significant building booms in the industrial space if those tariffs lead to a reshoring of American manufacturing,” said Esposito, who conceded that the higher tariffs might “lead to price spikes and further inflation” if they aren’t administered thoughtfully. 

At the end of the day, no matter what Trump does, interest rates — both the short- and long-term rates — will remain high so long as the U.S. economy, the Federal Reserve, and a new administration are consumed by the threat of inflation. 

Perhaps most worrisome to some commercial real estate executives is that the drivers of the U.S. economy today are no longer traditional goods and services, but primarily asset-light industries like technology and online services, which are mostly immune from higher rates. Commercial real estate, on the other hand, is entirely asset-based, making the Fed’s intractable battle against inflation a proxy war against real estate, as every interest rate hike brings cap rates higher and values lower. 

“The assets today are intellectual capital, so the interest rates haven’t hurt asset-light businesses very much at all, and that’s probably why the Fed has had such little impact on the economy in total,” said Boesky. “However, they’ve sacrificed the real estate industry because of that, so it’s been very difficult.”

Brian Pascus can be reached at bpascus@commercialobserver.com