Fed’s potential rate cuts ‘not enough to bail out most people’

Interest rates have vexed commercial real estate all year, and top executives are weighing how the cost of borrowing may generate or kill opportunities in 2024.

The US Federal Reserve voted to keep rates steady last week at 5.25 to 5.5 percent – a 22-year high. But chair Jerome Powell gave his clearest indication yet that the benchmark would likely come down in 2024. Wall Street continued its rally Tuesday off the back of the news, even as officials moved to temper expectations and other central banks stressed the fight against inflation was ongoing.

The heighted rate environment over the past 18 months has thrown cold water on the market bringing deals to halt. In the US, commercial real estate investment volume dropped more than 50 percent in the third quarter, according to CBRE, with elevated rates a major factor to blame. Many of those looking for investment opportunities had expected next year would bring a new crop of forced sellers, but the promise of sliding rates could bring that to a halt.

“I really thought 2024 was going to be a year of tremendous transaction volume where there would be modest distress, and we’d reset prices. This was before the Fed announcement,” Richard Mack, CEO of Mack Real Estate Group, said. “Now, what I’m a little worried about is that there’s going to be too much exuberance and that people will be waiting for rates to come in and cap rates to go down.”

Between 2022 and 2023, the Federal Reserve increased rates 11 times to slow inflation. The higher-rate environment has heaped pressure on owners of leveraged assets facing a far tougher refinancing environment than years previous. Some $1.5 trillion of commercial real estate debt is set to come due by the end of 2025, per Morgan Stanley.

Mack was expecting some owners in 2024 to address issues in their portfolio and sell at a loss to get rid of underperforming assets. But with the hope of rates normalizing, sellers may not be as motivated to offload their properties. “So, we might have a little less buying opportunity. However, if this happens, redevelopment, repositioning, value add and or development opportunities will attract more capital in an environment where buying distress is less available.”

Specifically, Fed members said rates could move down to between 4.5 and 4.75 percent next year while still keeping inflation in check. The European Central Bank took a different stance, signaling cuts were not imminent, as did the Bank of England. 

Regardless of the comments, lenders are still extremely cautious, said Ward Fitzgerald,  CEO of EQT Exeter. “It’s going to be ’25 or ’26, before everybody really is exuberant again, and can get behind liquidity, trade volumes and those types of things,” he told PERE. “Effectively, [lenders] are saying, ‘We’re not doing a lot of business’… that right opportunity has become so narrow today, that they’re nearly not lending.”

Harbor Group International CEO Jordan Slone said the immediate impact of Powell’s comments has been, in the past week, a rush to refinance. He said though his firm does not have significant amounts of floating-rate debt, his team is working on purchasing new hedges that now are less expensive than a few months ago. They are also looking to refinance at a new fixed rate. Furthermore, he thinks acquisition activity will pick up, as interest rates and cap rates become more closely aligned.

Unlike Mack, however, Slone is not expecting a slowdown in distressed assets being put on the market next year, as sponsors throw in the towel. “There’s a lot of properties that are significantly overleveraged – and even the decrease in rates that we’ve had over the last 45 days or so, that’s not enough to bail out most people. People will not be able to tolerate it.”

From the perspective of Amsterdam-based Bouwinvest Real Estate Investors –  which has €15.1 billion of assets across five Dutch property sector funds and three international real estate investment mandates – the era of rate hikes is over. The investor is in opportunity mode, with the expectation of the market bottoming out mid-2024. “I don’t expect a big bang reaction,” Stephen Tross, CIO of international investments, said of the real estate market response to Powell’s comments last week.

“Upcoming debt maturities will impact transaction activity in real estate markets and it will lead to opportunities for patient investors with dry powder in 2024. Will it completely turn the market upside down? I don’t think so… [but] we had figured in some rate cuts a little later, so our current thinking is that it’s been pushed forward a bit.”