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Commercial real estate investors, owners and occupiers all have been monitoring whether the Federal Reserve will impose interest-rate cuts in 2024 after rapidly rising rates have substantially increased the cost of doing business.

Earlier this month, the Fed signaled it needed to see more progress toward its inflation target of 2% and decided to maintain its key lending rate. At that meeting, Fed Chairman Jerome Powell said gaining greater confidence around inflation “will take longer than previously expected,” although he also said he felt inflation would move back down in 2024.

For executives in commercial real estate, waiting for those rate cuts may prolong the uncertainty being felt in the market today.

Mark Roberts, managing director of research at Dallas-based real estate investment and development firm Crow Holdings, said the underpinnings of why the Fed hasn’t cut interest rates — a strong economy and labor market — are actually good fundamentals for commercial real estate.

He added that for many buyers and sellers of real estate, a reset to the new rate environment has already begun, noting that values are down on average 22% in the past seven quarters. That’s unlocked some deal momentum, but cumulative transaction volume in the first quarter of this year was still at its lowest level since 2013, according to Altus Group. It estimated $31.6 billion transacted across major property types in the U.S. in the first three months of the year, down 28% compared to the same quarter last year.

“The other side of the coin is, what does it mean for those who utilize a lot of leverage in their investments?” Roberts said. “For leveraged buyers, it’s not necessarily the best time, and that’s why a lot of dry powder is stacking up.”

Others in commercial real estate echoed that sentiment, saying there’s a lot of capital sitting on the sidelines that hasn’t yet been deployed — waiting, in large part, for more certainty in the broader U.S. economy.

At the end of 2023, when the 10-year Treasury rate had dropped to below 4% and borrowing rates began to stabilize, there was a greater sense of optimism that that capital raised would be put to work sometime this year, said Andrew Alperstein, partner at PricewaterhouseCoopers LLP’s financial markets and real estate group. But a stronger-than-expected economy this spring has dampened some of the optimism around any forthcoming rate cuts.

Still, even if cuts were to occur later or are more modest than previously expected, Alperstein said most real estate principals have accepted that a sub-3% environment isn’t coming back anytime soon and have begun re-pricing within the new market conditions.

“There’s a reality that has set in that rates are going to be at least moderately higher for a period of time, and investors will hopefully move forward on that premise,” Alperstein said. “What we’ve also seen is that sellers have not really been wanting to sell unless they had to. Folks have been watching closely for evidence of distress sales and forced sales — and yes, we’ve seen some, but not as many as people probably thought. We’ve got an interesting couple of quarters ahead.”

Buyers right now are generally motivated because of equity that’s available, Alperstein said. And more borrowers may be forced to make decisions on their CRE-backed loans if a higher-than-longer rate environment persists.

But more deals in general will mean broader confidence in the market on what the new norm is in returns and values, Alperstein said.

“That will hopefully be a positive thing,” he said. “I think we hoped we’d get this sooner, but some of the uncertainty around rate cuts and the increase in the 10-year [Treasury rate] has slowed that progress.”

Ripple effect on leasing decisions

Although a delay in interest-rate cuts arguably has the most direct impact on commercial real estate buying and selling, it’s also factoring into how companies think about their real estate leasing decisions.

Rob Kane, senior executive vice president and co-leader of Dallas-based Lincoln Property Co.’s corporate advisory and solutions group, said the cost of capital and interest rates ripple through most every significant decision among the occupiers with which his firm works.

“If rates are higher for longer, it means continued uncertainty around decision making,” Kane said. “Internally, it means their business is more expensive to run, and I think we’re seeing, in certain cases, a lot of focus on capital containment and preservation. It’s very difficult for a [chief financial officer] to make a long-term decision when they have uncertainty around long-term rates.”

The past four years have been marked by uncertainty around real estate decisions by companies large and small, with many opting to sign short-term renewals as they figure out how much space they need in a post-pandemic world that embraces hybrid work. Some of that uncertainty has begun to ease, with a greater number of office tenants signing longer deals and relocating to newer towers, but a higher-for-longer rate environment may mean other companies will continue to prolong more-permanent space decisions.

It’s become common for companies to take less square footage in higher-quality office buildings, Kane said. He added that while some tenants will opt to delay their decision-making in an effort to cull spending during a higher-for-longer market, others will try to seize opportunity now.

“There are a significant number of companies … that will be able to make decisions and are going through the process to take advantage of the volatility to trade into higher-quality assets,” Kane said. “I think you’re going to continue to see that playing out across the country.”

That, in turn, will have wide-ranging effects on lenders and owners, Kane said, including accelerating the amount of distress facing lower-quality properties, which tenants are leaving in favor of newer buildings.

Impact on new construction

Since the Fed began increasing interest rates in 2022, new construction across major commercial real estate sectors has slowed.

Industrial construction starts dropped for the sixth consecutive quarter, to less than 40 million square feet breaking ground in Q1. For 2024, CBRE Group Inc. previously forecast that multifamily starts would fall by 45% this year from their pre-pandemic average and by 70% from their 2022 peak.

Office, the most challenged commercial real estate sector, has seen new-construction groundbreakings decline for five consecutive quarters, according to Jones Lang LaSalle Inc. In Q1, JLL recorded less than 300,000 square feet of office construction starts, the lowest total in nearly 40 years of data.

As the cost of financing remains higher than where it’s been recently, and traditional CRE lenders remain more tepid in their lending to the sector, that’ll continue to dampen the future pipeline for most property types, including traditionally hot ones like multifamily and industrial.

“The returns that developers need to target are just not going to be achievable with the cost of financing and the cost of construction and the availability of financing,” Alperstein said. “As we look out 24 months, there’s going to be a window of time there where there will be very little new supply hitting the market, and that will most likely be positive for the fundamentals of multifamily, industrial and even some retail.”

Roberts said persistently higher interest rates will mean the next real estate cycle will shift into a new equilibrium in supply and demand, where structural occupancy rates will be higher than where they’ve been in recent years,

In industrial real estate, for example, the long-term occupancy rate in the past 20 years has hovered about 93%, but the long-term average will start to move higher, closer to 97%, Roberts said. That overall is a good thing, to sustain the warehouse market’s investment environment, he added.

Some owners and developers will continue to turn to new or alternative financing mechanisms to get deals done — including new construction, experts say.

“There is capital out there for creative financing,” said Brent Maier, real estate advisory leader at Baker Tilly. “It comes down to relationships and the appetite for cost. If you go to a nontraditional lender, sometimes that money can be more expensive, but if you have a good asset or a good deal, it generally pencils out if it is attractive.”


Source:  SFBJ

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The Federal Reserve usually speaks as one. But it’s a big organization with many individuals, including those with their own reputations and areas of responsibility. And some have been coming out to question how many, or if any, interest rate cuts will be on the table for 2024 at all.

Neel Kashkari, president and CEO of the Federal Reserve Bank of Minneapolis, is the most recent voice wondering what degree of cuts might be possible. He wrote about the multiple factors that were making any prediction difficult. Disinflation has “stalled,” underlying economic demand has remained strong, and monetary policy is “much tighter” than before the pandemic.

In a discussion at the 2024 Milken Institute Global Conference in Los Angeles, California, replying to questions from New York Times’ economic reporter Jeanna Smialek, he said, “Inflation seems to have gone sideways while economic growth has remained resilient. It’s led me to question is monetary policy having as much downward pressure on demand as I would have otherwise expected.”

He pointed to the housing market, which has remained “remarkably resilient” given 30-year mortgage rates up to about 7.5%. He acknowledged questions about whether the so-called neutral interest rate — the short-term interest rate when the country sees full employment and stable inflation — might be higher than what the Fed has expected. It’s a point that Vanguard has raised.

If the neutral rate was higher than Fed estimates, “Instead of two feet down on the brakes, maybe only one, or possibly not much at all,” Kashkari said.

There are multiple scenarios he offered going forward, “the most likely” being that “we stay put for an extended period of time, until we get clarity on is disinflation in fact continuing, or has it, in fact, stalled out.”

If disinflation starts again or the country sees “marked weakening in the labor market,” there might be interest rate cuts this year, Kashkari said. “Or if we got convinced eventually that inflation is embedded or entrenched now at 3% and that we need to go higher, we would do that if we needed to.” “That’s not my most likely scenario, but I can’t rule it out.

Back in January, Christopher Walker, a Fed governor, notedthat economic news at the time was good.

“But will it last?” Walker asked. “Time will tell whether inflation can be sustained on its recent path and allow us to conclude that we have achieved the FOMC’s price-stability goal. Time will tell if this can happen while the labor market still performs above expectations. The data we have received the last few months is allowing the Committee to consider cutting the policy rate in 2024. However, concerns about the sustainability of these data trends requires changes in the path of policy to be carefully calibrated and not rushed.”


Source:  GlobeSt.

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A lot of financing and refinancing strategies among CRE owners have become waiting games. Hold until interest rates eventually go down — putting off loan maturities or new purchases as much as possible — until they can get themselves out of trouble.

One of the types of tools for floating rate interest loans have been interest rate caps, which offer some protection against the increase of interest rates when some benchmark like SOFR crosses a threshold. At least until the rate cap fees started jumping in 2020 and the costs started to crush transactionsby May. Things continued to get worse by October. And then … they kept getting worse. In 2023, the rate cap cost increases were crushing even more CRE transactions.

Concerns eventually started to ease as inflation seemed to be coming under control and there was a growing thought that the Federal Reserve would start cutting rates. Three times during 2024. Granted, that three cuts of probably 25 basis points each would be less than now, but the total 75-basis point amount wouldn’t be terribly compelling.

However, the thought of future rate cuts provided hope. Not now.

“The one-month forward curve shows that investors now think the secured overnight financing rate, or SOFR, which is closely related to the federal-funds rate, will be 4.825% at the start of 2025,” the Wall Street Journal wrote. “This implies up to two small cuts this year. Back in January, six cuts were expected.”

An improvement of cap rates had begun because the risk of the provider having to cover higher interest rates looked as though it would slow and then abate. Not now, because the expectation for rate cuts is becoming more pessimistic.

“The cost of these caps has become a major headache for property owners, according to Carol Ng, a managing director at risk-management firm Derivative Logic,” the Journal wrote. “The price of a one-year extension for an interest-rate cap on a $100 million mortgage at a 3% strike rate is now $2.1 million. Back in January, when the market expected more rate cuts, the same extension cost $1.3 million.”

But there are other estimates. Chatham Financial’s interest rate cap calculator looking at 3% constant SOFR strike rate on $100 million is almost $4.61 million, making that $2.1 million estimate look good in comparison.


Source:  GlobeSt.

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The multifamily fall from grace over the last couple of years was unexpected by most at the market’s pandemic highs. The increase in interest rates have hit hard, as have some other factors.

But according to Ralph Rosenberg, partner and global head of real estate at global investment firm KKR, problematic conditions should start tapering off after 2025, leaving strong possibilities for rent growth and opportunities to “buy high-quality properties below replacement cost while achieving attractive long-term yields.”

The factors confounding multifamily certainly start with interest rates.

“Debt levels relative to equity are higher in multifamily than in some other segments, a loan maturity wall looms, and interest rate caps are expiring, putting many owners in the position of refinancing at a time when their properties are worth less than their acquisition basis and interest rates are much higher,” Rosenberg wrote.

He notes that multifamily is one of the most leveraged of CRE investments. That makes refinancing challenging. There is a loan maturity wall, reduced availability of financing, and high debt loads.

That’s only one part. As has previously reported, 2023 saw a record number of apartment unit deliveries added to inventory and 2024 is expected to top that by half again. These aren’t evenly distributed across the country, but the concentration in places even with high increases in population is still enough to depress prices, occupancy rates, and rent growth.

In addition, operational costs have increased.

“Floating-rate interest payments rose faster than income from rent and fees,” the firm said. Falling valuations aided in negatively affecting debt service coverage ratios, making many properties fiscally unsustainable to the lender. Also, utilities and property taxes have continued to climb, adding to multifamily difficulties.

“Over $250 billion in multifamily loan debt matures in 2024 alone, and some owners will face a gap upon refinancing,” they wrote. “Likewise, as interest rate caps typically last for three years, many owners are looking at a sharp increase in the cost of debt.”

KKR expects a tough couple of years in a deleveraging cycle. Owners and investors who can hold on during this period face different conditions coming out. There is the chance of lower interest rates, although the degree and pace of any reductions are up in the air now. Demand for units will grow as the rising expenses and difficulty of continuation of building make it virtually impossible to keep pace with additional units. Currently, supply growth forecasts for many metropolitan areas are below the 2018-to-2022 five-year average, and that wasn’t adequate to satisfy market needs.

Buyers with sufficient resources will find many opportunities.

“Consider what would happen to a multifamily property purchased in February 2024 at a 5.5% cap rate (a measure of the one-year yield on a property calculated by dividing NOI by asset value) with 50% leverage,” they wrote. “Assume that NOI grows at a 3% CAGR. As interest rates come down, it might be possible to sell at a cap rate of 5.0% five years later, in 2029. That equates to an internal rate of return of roughly 14.5% over five years, which is attractive for a historically stable, in-demand asset class.”


Source:  GlobeSt.

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Cap rates for the single-tenant net-lease sector increased for the eighth consecutive quarter in Q1 2024, jumping to an average of 6.64% across all major asset types.

STNL asking cap rates for office properties hit 7.6% in Q1, followed by industrial, which averaged 7.02%, and retail, which jumped to 6.42%, according to the latest market report from The Boulder Group.

According to The Boulder Group’s Jimmy Goodman, the current cycle of STNL cap rate increases is the longest since 2014. In an interview at GlobeSt.’s Net Lease conference in NYC this week, Goodman said STNL cap rates will remain elevated until the Fed starts cutting interest rates.

“I think we’re at status quo, this is the new normal until the Fed moves to cut rates,” Goodman said. “Everyone had this level of hope last year that we would have rate cuts this year, but 2024 is looking a lot like 2023.”

“Now, people are hoping for a rate cut in Q3, but it probably won’t be a large cut,” he added. “Until then, nothing will change. Cap rates will increase or plateau. I don’t see them decreasing any time soon.”

The new status quo also is likely to keep transaction volume at a minimum — one description we heard is “flatlining” — as buyers are few and far between and sellers refuse to reprice their deals to higher cap rates.

Most of the players in the STNL market are in it for the long-term, typically with 10- or 20-year leases, and they can wait out the down cycle, Goodman noted.

“It’s a steady cash flow. The lenders, the equity, they know they’re going to get a check from the tenant,” he said. “If a $2M Starbucks just got built, it’s got a 10-year lease and they know they’re going to get paid.”

Sellers are still in denial about bringing their pricing in line with the new status quo on cap rates, Goodman suggested.

“If you’re a developer, you still want to make money off your merchant developer deals. The public REITs and people that are subject to financing can’t pay the cap rates the developer wants, and the developer doesn’t want to be upside down,” he said.

“Everyone is staring at each other and nobody is blinking,” Goodman added.


Source:  GlobeSt.

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In the latter half of last week, yields on Treasury 10-years jumped, hitting 4.55% on Wednesday, moving to 4.56% on Thursday, and dropping down to 4.50% on Friday. By the end of Monday, it was 4.63%

If you ignore 2023 when rising interest rates had a heavy impact on Treasury yields, the last time the 10-year was in this range was in the fall of 2007, as the initial rumblings of what would become the Global Financial Crisis.

Markets are not seeing the trembling of an out-of-control housing market and the derivatives built on top of it. But the current shakings might be worse.

“A series of weak auctions for U.S. Treasurys are stoking investors’ concerns that markets will struggle to absorb an incoming rush of government debt,” the Wall Street Journal reported. “A selloff sparked by a hotter-than-expected inflation report intensified this past week after lackluster demand for a $39 billion sale of 10-year Treasurys. Investors also showed tepid interest in auctions for three-year and 30-year Treasurys.”

The worry among investors is that if inflation doesn’t continue to sink, the Federal Reserve will keep interest rates where they are now rather than start cutting as investors have wanted. Or maybe increase rates if they decide it’s necessary to break the back of rising prices.

May will bring another $386 billion in bond sales, and, as the Journal notes, this will continue no matter who is elected president in November. The first quarter of 2024 saw the Treasury sell $7.2 trillion in debt. Last year, the government issued $23 trillion in Treasurys, “which raised $2.4 trillion of cash, after accounting for maturing bonds.” But a number of Treasury auctions did more poorly than expected. The Treasury Department decided to push short-term instruments as the Fed encouraged the idea that eventually they would cut interest rates. That would make higher-rate Treasurys more valuable in a presumed near term.

With inflation started to strengthen again, that strategy becomes less appealing to buyers. Also, the Fed has said it will slow quantitative tightening, which is how it reduces its balance sheet holdings of Treasury instruments. Tightening expects that investors would buy more debt. As the Fed reduces tightening, the government might lower its expectations of how much investors needed to buy.

From a CRE perspective, the more debt on sale, the greater degree that circumstances invoke the law of supply and demand. Prices will likely drop to get enough investor purchases, which would send yields up as the two aspects move inversely. The 10-year yield is one of the standard baseline rates used in CRE lending. The other, the Secured Overnight Financing Rate, or SOFR, is strongly correlated to the 10-year, though often with a timing gap.

If baseline rates go up, so do borrowing costs, which is the big problem faced by many with maturing loans and who need refinancing but who based their business case on low interest rates and high leverage that are no longer available.

And then there is the psychological factor. All investors, whether individuals, organizations, or sovereign states, are under the thumb of human emotion. The more risk they perceive, the more skittish they are as buyers, which could push down Treasury prices even more, driving up expected yield and negatively affecting CRE.


Source:  GlobeSt.

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Wednesday’s Consumer Price Index numbers were higher than expected, sending Wall Street into a swoon about what it could mean.

For starters, it’s just about a given that, following this latest evidence that prices are not declining as fast as had been expected, the Fed will delay implementing its promised rate cuts. But some prominent voices are wondering about a worse case scenario: that the Fed might actually start raising rates. If this were to come to pass, simply put it would raise havoc in commercial real estate. has heard repeatedly over the last few months that transactions were resuming in part because the market believed that the Fed was done raising rates, introducing some much-needed certainty into forecasts.

Former Treasury Secretary Lawrence Summers is one of these voices.

“You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” Summers said on Bloomberg Television. He said such a likelihood is somewhere in the 15% to 25% range.

The odds still do favor a Fed rate cut this year, “but not as much as is priced into markets,” he said.

Also, Federal Reserve Governor Michelle Bowman said earlier this month that it’s possible interest rates may have to move higher to control inflation.

“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said in a recent speech to the Shadow Open Market Committee in New York.  “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2 percent over the longer run.”

Bowman is a permanent voting member of the Federal Open Market Committee.

JPMorgan Chase CEO Jamie Dimon has also floated the possibility that rates could increase in his letter to shareholders. The investment bank is  preparing “for a very broad range of interest rates, from 2% to 8% or even more,” he wrote.

These voices, though, are in the minority. Right now, most analysts have coalesced around the theory that rate cuts will be delayed this year.

Less than 24 hours after the CPI was released, Wall Street economists began revising their outlooks. Goldman Sachs and UBS now see two cuts starting in July and September, respectively, while analysts at Barclays anticipate just one reduction, in September, according to the Wall Street Journal.

Others are even more pessimistic about the timing.

“The lack of moderation in inflation will undermine Fed officials’ confidence that inflation is on a sustainable course back to 2% and likely delays rate cuts to September at the earliest and could push off rate reductions to next year,” Kathy Bostjancic, chief economist at Nationwide, said in a research note that was reported by The Associated Press.

Right now the Fed’s official expectation is that inflation continues to move down albeit in an uneven trajectory. If this is true, then rate cuts are still likely this year.

However, Wall Street worries that inflation has stalled at a level closer to 3% and if the evidence bears this out in future reports, it is conceivable that the Fed could scrap cuts altogether.

One indicator that does not bode well for rate cuts this year is the so-called supercore inflation reading, which besides excluding the volatile food and energy prices that the core CPI does, also strips out shelter and rent costs from its services reading.

Supercore accelerated to a 4.8% pace year over year in March, the highest in 11 months, according to CNBC.

Tom Fitzpatrick, managing director of global market insights at R.J. O’Brien & Associates, told the publication that if you take the readings of the last three months and annualize them, the supercore inflation rate is more than 8%.

All this said, the Fed has promised it would cut rates three times this year and that is a hard promise to unwind. The upheaval a rate hike would cause would give the institution a black eye even worse than its promises a few years ago that the creeping inflation in the economy was transitory.


Source:  GlobeSt.

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A drumbeat for stagflation as a possible scenario for the US economy is growing louder.

Last week, strategists from the Bank of America wrote that the macroeconomic picture is “flipping from goldilocks to stagflation,” which they defined as growth below 2% and inflation of between 3% and 4%. Inflation is higher in developed and emerging markets, while the US labor market is “finally cracking,” wrote Michael Hartnett.

JPMorgan Chase’s Marko Kolanovic raised similar concerns in February. A halt in inflation’s downward trend, or price pressures broadly resurfacing “wouldn’t be a surprise” given outsized gains in equities, tight labor markets and high immigration and government spending, he said, according to Bloomberg.

Between 1967 to 1980, stock returns were nearly flat in nominal terms as inflation came in waves, with fixed-income investments significantly outperforming while stock returns were nearly flat in nominal terms. Kolanovic sees “many similarities to the current times.”

“We already had one wave of inflation, and questions started to appear whether a second wave can be avoided if policies and geopolitical developments stay on this course,” he said in his note, adding that inflation is likely to be harder to control as stock and cryptocurrency markets add trillions of dollars in paper wealth and quantitative tightening is offset by Treasury issuance.

Recent economic reports back up these analysts: The February Consumer Price Index came in at a higher-than-expected 3.2% year over year. Retail sales reported on Friday rose 0.6% from January to February, falling short of projections expecting 0.8% growth.

The Wall Street Journal highlighted these developments but ultimately dismissed the idea of stagflation taking hold in the US economy. So have the equity markets,

Barclays Plc strategist Emmanuel Cau wrote in a note that was reported in Bloomberg.

“With the Fed so far endorsing current market pricing of three cuts starting in June, investors continue to see the glass half full on the soft landing narrative,” he said.

This week the Federal Open Market Committee will meet and the minutes it releases will show how Fed officials’ thinking changed from recent bad data on inflation.

One sign doesn’t bode well for Fed watchers hoping for rate cuts to happen sooner than later.

More than two-thirds of academic economists polled by the Financial Times believe that the Federal Reserve will be forced to hold interest rates at a high level for longer than markets and central bankers anticipate. Respondents to the FT-Chicago Booth poll think the Fed will make two or fewer cuts this year with the most popular response for the timing of the first cut split between July and September.

“The Fed really wants to cut rates. All of the body language is about cutting. But the data is going to make it harder for them to do it,” Jason Furman, an economist at Harvard University, who was one of 38 respondents polled this month, told the FT. “I expect the last mile of inflation to prove quite stubborn.”

However, there is one viable theory for rates in June. Vincent Reinhart, a former Fed official who is now chief economist at Dreyfus and Mellon, told the FT that politics will play a role in the timing this year.

“The data say the best time to cut rates is September, but the politics say June,” said Reinhart, who did not participate in the poll. “You don’t want to start cuts that close to an election.”


Source:  GlobeSt.

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It’s “unlikely” that market interest rates will return to levels before the pandemic, US Treasury Secretary Janet Yellen said to reporters yesterday in comments that were published by Bloomberg.

A reporter asked Yellen why the White House projections that were part of President Joe Biden’s $7.3 trillion fiscal 2025 budget proposal showed higher expectations for interest rates in coming years compared with projections a year ago. Yellen said the new numbers were in line with private sector forecasts.

“I think it reflects current market realities and the forecasts that we’re seeing in the private sector — that it seems unlikely that yields are going to go back to being as low as they were before the pandemic,” she said.

The budget proposal now assumes that the rates on three-month US Treasury bills will average 5.1% this year, up from the 3.8% projected last March. The projection for the 10-year yield is now 4.4%, up from 3.6%.

Meanwhile, some economists are beginning to think that it will be a long time for the Fed to reach its goal of 2% inflation and that 3% will be the new normal.

“Inflation was able to decelerate from 9% to 3% rather quickly, but the path to the Fed’s 2% target may take more time than expected,” Skyler Weinand, CIO of Regan Capital, told Axios.

Last week, the Labor Department reported that the Consumer Price Index grew 3.2%year over year.

Lara Rhame, chief U.S. economist at FS Investments, also believes that inflation will hover at 3% for the foreseeable future.

The Fed is “going to err on the side of caution in terms of cutting too quickly,” Rhame said to Axios.


Source:  GlobeSt.

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There seems to be hope abounding in commercial real estate, according to the Federal Reserve’s Beige Book. Optimism tends to look toward the future — in this case, when the industry hopes interest rates will drop.

In the reality of the moment, though, that hasn’t changed how higher rates are still limiting real estate deals, as reported by the various Federal Reserve district banks and what they’re hearing from people in their multi-state regions. And the optimism may ultimately end, as the excitement over interest rate reductions may be premature.

Consider the following excerpts from the report.

Boston: “Commercial real estate activity weakened further modestly, and the outlook in that sector remained mostly pessimistic, despite expected declines in borrowing rates. In the already-weak office market, vacancy rates increased moderately on average, and Providence in particular saw the exit of a large downtown tenant. Office rents fell noticeably in the Boston area in recent months but were reportedly stable (if low) elsewhere. Demand for life sciences space in greater Boston dwindled further to very low levels. In the retail market, rents and vacancy rates were mostly steady at moderate levels, although lower-end malls continued to see elevated vacancies. Demand for industrial space slowed further at a modest pace, but rents and occupancy rates were described as mostly stable at healthy levels. Projections for commercial real estate activity in 2024 were mixed but remained pessimistic on balance.”

New York: “Commercial real estate markets mostly held steady. New York City office vacancy rates were steady near historic highs and rents declined slightly. Upstate New York office markets saw continued increases in vacancy rates, but rents were unchanged. In the industrial market, small improvements were seen in downstate New York while conditions in upstate New York deteriorated. Construction contacts reported that activity declined modestly since the last report. Office construction dropped, but industrial construction grew with high volumes under construction and significant deliveries set for 2024 in downstate New York and northern New Jersey.”

Philadelphia: “In nonresidential markets, leasing activity and transaction volumes continued to decline slightly—more so in the office market in which existing tenants continued to downsize their space and upgrade their quality as their leases expired. In contrast, current construction activity held steady, although many contacts expect that the project pipeline will shrink before the end of 2024. New projects are slowly emerging in heavy industry and infrastructure.” However, banks in the region generally noticed modest growth in CRE loan volumes.

Cleveland: “Residential construction and real estate contacts reported that activity remained soft in recent weeks. However, one homebuilder reported an increase in inquiries as mortgage rates declined. Nonresidential construction rebounded in recent weeks. One commercial builder noted that declining interest rates and greater optimism about the economic outlook had boosted demand. Moreover, multiple general contractors reported that customers had elected to move forward with previously delayed projects. Commercial real estate and construction contacts expected demand to remain mostly stable in the near term.”

Richmond: “Overall market activity in commercial real estate was flat this period. Retail remained strong, especially with fast casual restaurant chains. In the office sector, Class A office space was tightening with more leasing activity related to firms upgrading their space and moving away from central business districts. A lack of available financing continued to constrain new development and refinancing within the broader CRE sector. Construction projects were mainly limited to the industrial and multifamily segments. Contractors noted that due to the high cost of construction there were few new CRE projects and, as such, their backlog of work was shrinking.”

Atlanta: “The Sixth District’s office market continued to encounter negative absorption rates and diminishing occupancies. Leasing activity at the end of 2023 dropped to 2020 levels, creating a ‘tenant’s market,’ where landlords were forced to offer incentives. Market conditions are expected to remain challenged in 2024 as new construction is delivered. Other property segments experienced weakening conditions as well; contacts in industrial markets reported that the amount of square feet in the pipeline is running well ahead of absorption, resulting in higher vacancy levels. Contacts expressed concerns over rising commercial real estate loan maturities in 2024.”

Chicago: “Construction and real estate activity was little changed on balance over the reporting period. Nonresidential construction activity increased slightly, while prices were unchanged. One auto dealership group said that the expectation interest rates would begin falling soon was a factor in their proceeding with a project to increase service-center capacity. Commercial real estate activity was unchanged. Demand for industrial properties remained at elevated levels. While prices fell slightly, rents, vacancy rates and the availability of sublease space were all unchanged.”

St. Louis: “Commercial real estate rental markets continue to be stagnant in the office sector for downtown areas. Contacts reported continued commercial real estate sales in Northwest Arkansas, including two large multi-family units and a couple of retail sales. A large multi-family community is expected to start construction in Northwest Arkansas in early 2024.”

Minneapolis: “Construction activity was lower overall since the last report. Among roughly two dozen construction contacts, recent sales were lower and profits have been particularly hard hit. Recent hiring demand has fallen somewhat, but sentiment was modestly more positive for the early part of 2024. Among sectors, firms in infrastructure continued to fare better thanks to federal spending. November and December commercial permitting was generally flat or lower in the District’s larger markets compared with a year earlier. Residential building was constrained in many markets, but single-family permitting in Minneapolis-St. Paul saw sustained increases for several months, including December. Commercial real estate was flat overall. Vacancy rates for industrial space have ticked higher thanks to significant speculative building in the last year. Office markets remained soft, and reports of tenant concessions were rising. Retail vacancy has improved modestly thanks to stronger foot-traffic trends and lower levels of new construction.”

Kansas City: “Contacts indicated transaction activity for commercial properties was suppressed in recent weeks. Potential buyers of many office properties, and some multifamily properties, were reportedly waiting for a bottom as loans are set to be repriced over the medium term. Those buyers not waiting on the sidelines were reportedly pricing to a bottom among distressed sellers, resulting in large spreads between bid prices and ask prices that made price discovery difficult in most markets. Some contacts suggested that transaction activity may pick up slightly in coming months as appetites for restructuring loans may increase after year end. Yet, falling rents and rising insurance costs adversely affecting net operating incomes remained widely cited concerns inhibiting loan restructuring when desired.”

Dallas: “Activity in commercial real estate was little changed. Apartment leasing picked up slightly though rents remained flat. Office leasing remained weak; vacancy rates were elevated, and concessions remained widespread. Industrial vacancy rates rose as new supply continued to outpace demand. Macroeconomic uncertainty, high capital costs, and reduced appetite to lend continued to deter investment sales and construction starts across property types.”

San Francisco: “Conditions in the commercial real estate market were mixed. While demand for retail and industrial space was solid, office leasing activity remained weak. Transaction volumes of commercial property sales were down as sellers’ asking prices exceeded what buyers were willing to pay. Construction activity reportedly slowed for private-sector commercial projects due to financing constraints, while construction of government public and infrastructure projects expanded. Challenges obtaining some materials, particularly electrical equipment, persisted.”


Source:  GlobeSt.