Anticipation is building as the Federal Reserve’s Federal Open Market Committee prepares for a potential interest rate cut. According to CME FedWatch’s 30-day fed funds futures pricing, there is a 69% chance of a 25-basis-point reduction and a 31% probability of a 50-basis-point cut.

Despite hopes that rate cuts might ease the refinancing pressures faced by many in commercial real estate (CRE), the actual impact remains uncertain.

Any rate cut is expected to be modest. FedWatch indicates a 77.5% chance of a total reduction between 100 and 125 basis points by the Federal Reserve’s December 12, 2024 meeting. Whether this will be sufficient relief depends partly on lenders’ decisions regarding their spread. According to Clark Finney, Vice President and Director at Matthews Real Estate Investment Services, the effects on asset values are complex and not easily predictable.

Lenders may not fully align with the Fed’s rate changes, especially if Treasury indexes are used for pricing coupons. Finney points out that CRE deals often anticipate rate changes well in advance. For example, the 10-year Treasury yield fell from 4.09% at the end of July to 3.65% by September 10.

A swift return to ultra-low rates is unlikely, as the current economic conditions are not as severe as those during the Global Financial Crisis or the COVID-19 pandemic, which led to rapid rate cuts.

Even if borrowing rates decrease promptly—though this is not guaranteed—cap rates usually take six to nine months to adjust. This lag provides investors an opportunity to act before the broader market fully absorbs the Fed’s actions. For instance, an investor might find a property with a 6.5% cap rate while financing costs are at 5.5%.

Ryan Severino, Chief Economist and Head of US Research at BGO, told GlobeSt.com that the short-term outlook for CRE equity involves a gradual increase in investment volumes and valuations. Cap rates are expected to compress more significantly, and total returns should improve as both short- and long-term yields decrease.

Regarding the short-term credit market, Severino anticipates a gradual rise in debt origination volumes as borrowing costs decline. However, loan performance will vary by property type, with offices facing ongoing structural challenges and multifamily properties dealing with issues related to variable-rate debt that has been affected by rising interest rates.

Source:  GlobeSt.