What Does the Fed’s Rate Cut Mean for CRE?
By Brandon Wilhite
Last week, for the first time since 2008, the Federal Reserve Open Market Committee voted to cut its key interest rate, the Federal Funds Rate, by 25 basis points (bps). While the US economy remains strong with unemployment rates at record lows, the Fed Chairman Jerome Powell characterized the move as a “mid-cycle adjustment to policy” citing inflation remaining below the Fed’s 2% target as well as other headwinds including a slowdown in global growth and the trade war with China.
Presumably, the rate cut aims to stimulate economic activity, particularly investments in assets such as commercial real estate. However, the efficacy of this unprecedented “mid-cycle adjustment to policy” on the commercial real estate sector is far from certain. Whereas historically, previous rate cuts occurred during recessions and times of economic uncertainty when the market needed the stimulus, via a lower cost of capital, to encourage investment activity, there is currently no shortage of investment activity in the sector.
Today, market values for most asset classes are at or near their peaks as a result of historically low cap rates and historically high rental rates. As a result, acquiring and developing assets at an appropriate basis has been increasingly challenging for many investors. Economic downturns or slowdowns, when the sector cools due to distress and uncertainty in the market, have been when many successful investors have made their most profitable investments due to their ability to develop or acquire at a relatively low basis.
The extent to which further accommodation by the Federal Reserve will have a commensurate effect on commercial real estate investment activity will be dependent upon how much additional growth investors feel the market has left in the cycle. With both property values and development costs at all-time highs, investors will be betting on further economic growth to propel rent growth in order to achieve desired returns on equity. Both investors and lenders, who often cite the now 10+ years duration of the cycle, may be less inclined to make that bet than they otherwise would.
While the 25 bps rate cut will certainly provide some level of stimulus to the commercial real estate market, the effect could be more muted than previous rate cuts. Our team at Metropolitan Capital Advisors (MCA) specializes in optimally engineering our investor and developer clients’ capital stacks to maximize their risk-adjusted returns.