With the arrival of the new year, the entire commercial real estate community remains saddled with interest rates generally in the 6’s. When a Harvard professor and CRE Investor Peter Linneman was asked recently why rates haven’t fallen with the Fed easing, he gave what has to be the most honest and transparent answer an economist has ever given: ‘I have no idea.’ In fact, his team went back looking for any other examples through the decades and only found one other short lived occurrence – and nothing like what we have seen since the lows of September on rates. That doesn’t sound like good news, but it is actually!
He went on the reference – albeit in the context of commercial real estate activity – that a tide doesn’t remain out forever. The CRE tide will come back in and does indeed from our perspective seems to have started late last year and is gaining some momentum.
While the same cannot be said of interest rates yet, there are signs that the needed lowering is beginning. At the start of the year, the 10-year spiked up to 4.81% – within spitting distance of the high last seen after the Fed ended tightening and inflation remained out of control. Since that peak, we have seen the treasury steadily decline with it now settling close to 4.4%. While not the 3.65% we saw in Q3 last year, it’s headed in the right direction. If history can be any guide and we know rates come down when the Fed eases, then it’s only a matter of time.
And that timing should prove beneficial to everyone – buyers, seller, and owners looking to refinance debt coming due or adjusting to a variable rate. For buyers, those rates obviously mean higher leverage. Given the rise in cap rates over the past year or more coupled with a drop in rates, we have actually been able to put together a few purchase in the 75-80% range (and that’s not a typo!). Rate settling not only signals higher leverage, it also brings buyers in off the sidelines who have simply been waiting for better cash on cash returns. For sellers, see the preceding comment! With more buyers coming into the market, there’s more competition which should put a halt on rising cap rates allowing sellers to retain more equity to put towards 1031 exchange purchases. Lastly, current owners with note storms on the horizon can begin breathing a little easier knowing exiting those loans is becoming easier as NOI presses loan proceeds less. Essentially the entire commercial real estate industry should begin seeing the benefits of rates easing more and more in the coming months.
The only hedge against that would be rates backing up again. So what are the chances of that happening. To use Dr. Linneman’s phrase… I have no idea! However, provided that the overall psyche of the funds and investors purchasing treasuries remains relatively positive and no outside forces disrupt the markets, the risks are low. There will be bumps along the way as few things in the markets heads in a constant straight line. However, it’s the trend line that matters – and the trend line looks pretty good right now.
While it may only be anecdotal evidence, we have seen the phone ringing significantly more since the start of the year and more emails coming all requesting help and guidance on CRE financing. Over half of those calls relate to purchases. All of that was noted by my assistant as a very distinct change from this time last year. All of us here hope that trend continues. There is indeed hope on the horizon!
