Commercial real estate recovery may be uneven

The tide could be turning for commercial real estate.

The Federal Reserve began its interest rate cutting cycle in September, lowering the Fed funds rate for the first time since 2020 by 50 basis points, while hinting that more cuts are on the horizon. That could give interest rate-sensitive sectors such as commercial real estate long-awaited positive momentum.

Lower interest rates make debt cheaper, helping to accelerate deal flow in an industry where deal activity had stalled into the second quarter of 2024. The CRE market had been pressured in the years after the initial Covid shutdowns, ending a nearly 15-year bull run in the face of higher borrowing costs, weak tenant demand and increased property supply. As a result, property values and sales declined.

The Fed’s shift in policy is “the most notable green shoot” for the CRE market, Wells Fargo analysts wrote in a Sept. 3 research note. While lower rates are not a “magic bullet,” the easing of the Fed’s monetary policy “lays the groundwork for a commercial real estate recovery,” analysts wrote in a follow-up report in late September.

For higher dividend-paying stocks such as REITs, lower rates make these fixed-income investments more attractive for investors. But the primary impact of interest rate cuts is psychological, according to Alan Todd, head of commercial mortgage-backed security strategy at Bank of America.

“Once the Fed starts to cut, they’ll continue along that path,” which fosters a sense of stability, Todd said. As the market feels more comfortable, it will “incentivize borrowers to get off the sideline and start to transact.”