A commercial building available for rent in Melville, New York, April 17, 2023.
Howard Schnapp | Newsday | Getty Images
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.”
CRE sales recovery
Refinancing and sales volumes are already picking up as sentiment around the sector improves, according to Willy Walker, CEO of CRE financing firm Walker & Dunlop, in an interview with CNBC in late September.
During the Fed’s tightening cycle, rising rates caused a standoff between buyers and sellers where buyers hoped for lower prices while sellers clung to inflated valuations. This stalemate froze the deal market, prompting investors to adopt a wait-and-see mindset, leaving many to wonder what’s next for the market.
But more recently, overall transaction volumes saw their first quarterly increase since 2022 in the second quarter of 2024, driven by sales in the multifamily sector, analysts noted.
More than $40 billion in transactions occurred during the second quarter, a 13.9% jump quarter over quarter, but still 9.4% lower year over year, according to real estate data intelligence firm Altus Group.
With deals ticking up and supply coming down, property valuations appear be improving as the MSCI U.S. REIT Index showed a steady increase since the spring into September, Wells Fargo analysts noted in their Sept. 25 research.
While these dynamics could set the stage for a broader recovery, with some major subsectors such as…