Can Fed's Rate Cuts Jumpstart The Struggling Commercial Real Estate Market?

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In September, the Federal Reserve kicked off an interest rate-cutting cycle, reducing the Fed funds rate by 50 basis points for the first time since 2020 and signaling that further cuts could be on the way.

This development may finally provide much-needed momentum to interest rate-sensitive sectors like commercial real estate.

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With lower interest rates reducing borrowing costs, deal activity may start picking up in an industry that had slowed significantly by the second quarter of 2024, according to CNBC. Since the initial COVID lockdowns, the commercial real estate market has faced pressures from higher borrowing costs, weak tenant demand and rising property supply, ending a nearly 15-year bull run and driving down property values and sales.

According to a Sept. 3 research report from Wells Fargo analysts, the Fed’s pivot is “the most notable green shoot” for the commercial real estate market. While lower rates are not a “magic bullet,” they suggest that the Fed’s easing monetary policy could lay the groundwork for a commercial real estate market recovery, analysts noted in a follow-up report in late September.

Lower rates enhance the appeal of high-dividend stocks like real estate investment trusts (REITs) as fixed-income investments. However, Alan Todd, head of commercial mortgage-backed security strategy at Bank of America, told CNBC that the main effect of rate cuts is psychological.

Todd said that when the Fed begins cutting rates, it’s likely to continue, creating a sense of stability. As confidence grows, borrowers will be encouraged to start transacting off the sidelines.

Willy Walker, CEO of commercial real estate financing firm Walker & Dunlop, told CNBC in late September that refinancing and sales activity are already gaining momentum as sentiment improves in the sector.

Increasing interest rates led to a standoff during the Fed’s rate-hiking cycle. Buyers held out for lower prices, while sellers maintained high valuations, effectively freezing deal flow and pushing investors into a wait-and-see approach.

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Analysts report that overall transaction volumes recently rose for the first time since 2022, with the second quarter of 2024 seeing an increase largely driven by multifamily property sales.

According to data from Altus Group, more than $40 billion in transactions were completed in the second quarter, marking a 13.9% increase quarter-over-quarter, though still 9.4% lower than the previous year.

With deal activity climbing and supply easing, property valuations appear to be improving. The MSCI U.S. REIT Index has shown steady gains from spring through September, Wells Fargo analysts noted in a Sept. 25 report.

While these trends could lay the groundwork for a broader recovery, some subsectors, like commercial retail real estate, may follow at a different pace, making the path ahead likely uneven.

The commercial real estate market office sector still faces numerous challenges, though there were slight improvements in the second quarter.

For the first time since 2022, office net absorption – a key industry metric tracking changes in occupied space – turned positive, with more than two million square feet occupied over the three months, according to Wells Fargo.

However, Wells Fargo analysts note that headwinds still greatly outnumber the tail winds for the office sector, as hybrid work and slower office job growth continue to dampen demand. Prices are down 48.7% since 2019.

In contrast, according to Wells Fargo, multifamily real estate assets have seen a rise in demand, with net absorption reaching its highest level in nearly three years during the second quarter.

The growth comes even as multifamily construction surges, with completed units expected to surpass a record 500,000 this year, according to REntCafe data. Developers are on track to deliver 518,000 rental units by the end of 2024.

Once a standout in the commercial real estate market during the pandemic, when rent growth hit double digits in 2021, the multifamily sector has seen that growth slow to around 1%.

The current interest rate environment has created an incredible opportunity for income-seeking investors to earn massive yields, but not through publicly-traded REITs.

Arrived Homes, the Jeff Bezos-backed investment platform, has launched its Private Credit Fund, which provides access to a pool of short-term loans backed by residential real estate with a target 7% to 9% net annual yield paid to investors monthly. It paid 8.1% in August. The best part? Due to high demand the maximum investment amount is currently $5,000 with a minimum investment of ONLY $100.

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This article Can Fed’s Rate Cuts Jumpstart The Struggling Commercial Real Estate Market? originally appeared on Benzinga.com