The U.S. Federal Reserve said it is making a half-percentage-point cut to its benchmark interest rate, a long-awaited move that real estate investors hope will be a first meaningful step toward a recovery of property values, deal volume and development activity.
The formal announcement Wednesday followed strong hints from Federal Reserve Chair Jerome Powell that such a move was imminent, after rates were increased 11 times from early 2022 to mid-2023 to cool inflation.
The move was one of an expected series of cuts that could provide relief to property owners. The initial cut came amid signs of a slowing economy, such as a slowdown in hiring, adding complexity to the Fed’s balancing act to avoid both reigniting inflation and pushing the country into a recession.
The half-point cut was a pleasant surprise based on expectations of a quarter-cut circulating the commercial real estate industry, said Susan Gwin Burks, a senior vice president of investment sales in Avison Young's Dallas office.
"Our industry got knocked down pretty well following the beginning of the COVID-19 pandemic, and this helps us get back on track to see the growth that we need for our industry, which plays a big role in the economic success of our country," Burks told CoStar News.
Even though nothing immediate is expected from the half-point cut, she said it will probably take would-be buyers off the sidelines and push sellers to update their valuations to get properties poised and ready for market.
This week, a Dallas-based developer working with Burks and her team were contacted by lenders — a move unheard of in recent months — in hopes of offering some construction financing for a new apartment project on a North Texas tract. To Burks, she said it is these moves in the market that signal a trend of what is to come as more confidence seeps into the industry.
What the Fed said
“The committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run,” the Fed said in a statement explaining its decision.
“The committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” the statement said. “The economic outlook is uncertain, and the committee is attentive to the risks to both sides of its dual mandate.”
Powell said during a news conference that “we are not on any pre-set course.”
He added that decisions on additional changes to the rate will come meeting to meeting, based on evolving data.
The new target rate is 4.75% to 5%. Powell said the Fed projects the interest rate falling to about 4.4% by the end of this year and 3.4% by the end of 2025.
How soon and how significantly a change in interest rates will affect deals is likely to vary by market and even more so by property type, real estate professionals told CoStar News.
Office woes
Facing perhaps the steepest climb back from value loss is the office sector, said Michael Silver, chairman and managing broker of Chicago-based tenant advisory and management firm Vestian.
Many lenders have frozen or nearly frozen loan-making on corporate space, in part because they don’t want to take possession of such real estate if a deal sours in the coming years, Silver said.
“Even if interest rates drop a full 100 basis points over a year, what does it do for office values? Not much,” Silver said. “The lenders that typically would provide debt on office loans don’t want to lend. They don’t like the collateral.”
Remote and hybrid work trends that have persisted more than four years since the onset of COVID-19, combined with other factors such as corporate cuts and plunging office values, have left some landlords unable to fund new leases or refinance buildings as loans mature.
The challenge in financing an office acquisition or recapitalization isn’t the interest rate, it’s the lack of mortgage availability at any rate, Silver said.
“Interest-rate drops are divorced from what buildings are worth today just because there’s so much vacancy,” he said. “I saw the market blow up in the 1990s, and it took a while before there was a recovery. That was a three-year issue, not a 10-year issue like we have now. The reason is, I still think there’s another shoe to drop with job reductions from" artificial intelligence.
The long road back
The past few years have “forced people to get incredibly creative in their capital stacks in order to acquire new assets,” said David Weitz, managing partner at Oak Row Equities, a real estate private equity and development company with about $1.6 billion in assets. The firm has offices in New York and Miami.
With inflation heading toward the Fed’s target, Weitz said Wednesday’s cut came at just the right time. “I don’t think that whatever happens today will be the last rate cut of an expected number of rate cuts to come,” Weitz added.
Moving forward, investors and developers may start to see “more consistency and some more predictability in the capital markets,” as the Fed continues to cut rates, with Weitz telling CoStar News that despite the relief, “You're not going to see … capital markets to just open up the floodgates and for commercial real estate to come rolling back, right? I think that'll take time.”
While banks across the country have reduced their exposure to commercial real estate, some have taken the opportunity to grow their portfolio.
“We took a very contrarian point of view as a bank. When a lot of banks started to pull back from commercial real estate and chose not to lend or to stay on the sidelines, we pushed forward,” said Calixto Garcia-Velez, CEO of BanescoUSA, a community bank with $4.17 billion in assets that operates out of South Florida.
“We don't make broad statements like some banks do of, 'Oh, we're not looking at office or we don't like retail, or we don't do multifamily,'” he added, saying “We've increased our market share because we weren't shy to keep doing commercial real estate transactions. We've seen a very substantial growth in the bank's loan portfolio over the last couple of years.”
In Garcia-Velez’s view, the rate cut demonstrates the Fed’s confidence that “the economy is headed for a soft landing, that inflation is obviously under control, and the outlook is positive. I think that, psychologically, it's a positive move for the country and for the economy. But I don't think, practically, it's going to be a material change yet.”
If and when subsequent rate cuts happen, that’s when Garcia-Velez thinks “projects that maybe have been tabled or put on the sidelines may begin to pencil out and work again financially.”
Construction pipeline
Reduced borrowing costs could have a more immediate effect on development pipelines, said Blas Puzon, chief investment officer at Chicago-based Draper & Kramer, a multifamily investor and developer with a nationwide portfolio.
Many projects have remained on the drawing board because of higher borrowing and construction costs amid broader inflation. Puzon said the slowdown in construction could help stabilize rents in some markets, particularly in the Sun Belt, where overbuilding has reduced rent growth compared with other markets where there has been little new construction.
“One thing I can be certain of is that a cut in rates should help with construction,” he said. “Construction loans are priced off short-term floating rates. It’s going to be market-specific whether it makes sense to start a project, but a lower rate definitely matters.”
The half-point interest rate cut by the Fed could give investors a much-needed nudge to bank on real estate, Evan Stone, founder and managing partner of boutique investment advisory firm Goodwin Advisors, told CoStar News.
"This is meaningful for properties that are performing," said Stone, whose firm is based in Dallas but does work nationally. "For the ones that aren't performing, the cost of debt is not going to help them. Their biggest issue is lack of leasing."
Office buildings are grappling with a lack of leasing activity, he added, with some areas with multifamily properties being hit by drops in effective rents, meaning trouble for property owners burdened by debt. Even with this cut by the Fed, Stone said there’s still an inverted yield curve and even if the Fed dropped interest rates 100 basis points, it wouldn’t mitigate the financial troubles tied to a 40% leased office building.
"There will be some relief, but it's not the ultimate answer with a lot of these banks not really lending on certain real estate," he said. "Hopefully this forces them to have to lend more to make up for some of their reduced interest revenue."
For stabilized properties, the cost of debt will be less expensive even if the full Fed rate cut isn't passed on to the borrower, Stone said. The rate cut offers industrial and well-leased apartment properties buoyancy in the market with them trading at lower costs, he added.
With the promise of another potential rate cut soon, Stone said he believes deal-making will be pushed into next year.