Is the CRE Market Ready to Turn?
When the Federal Reserve’s Federal Open Markets Committee decided to stand fast on the Effective Federal Funds Rate (EFFR) in July, Fed Chairman Jerome Powell suggested the possibility of a rate cut in September, depending on economic reports. One reason for the hinted cut was the Bureau of Labor Statistics’ July 2024 report, which noted that the unemployment rate increased to 4.3%, with 114,000 jobs added.
While the Fed hasn’t outright said “yes, we’re cutting rates in September,” Marcus & Millichap’s John Chang pointed out that Wall Street is already responding, with the 10-year Treasury falling below 4%. Additionally, “The real estate investor buzz has already begun, the market is beginning to turn and the investment climate is thawing. It’s almost like the combination of Chairman Powell’s commentary, together with the jobs report was a trigger,” said Chang, senior vice president, national director research and advisory services in a recently released video presentation.
“Capping” It Off
Chang said lenders are increasingly convinced that the Fed has completed its tightening cycle. The result is that those lenders are reducing their spreads. Meanwhile, the cost of debt capital is also decreasing. Added to this, “property values have edged lower, and cap rates have risen enough so that the spread between the 10-year Treasury and the average cap rate has widened to where deals make sense to investors,” Chang observed.
Here’s how the spreads appear based on asset type:
- Office: 390 basis points
- Industrial: 310 basis points
- Retail: 300 basis points
- Self-Storage: 280 basis points
- Multifamily: 200 basis points
Chang explained that while industrial had a fairly wide cap spread, that figure should be considered because “industrial” covers different commercial property subtypes. Furthermore, while the office numbers are concerning, “the spread over the ten-year is starting to capture some investors’ imaginations,” Chang noted.
The Outlook
Chang said that at the beginning of 2024, “near-record capital” was interested in commercial real estate but remained on the sidelines. Over the past couple of months, that’s changed, with some significant transactions closing. “The dry powder awaiting deployment has begun to draw down, and the race to place capital has started,” Chang said.
He ended the presentation by suggesting that potential investors ask themselves the following questions:
- Do you believe the Federal Reserve will lower rates?
- Do you believe that rate reductions will help spur the economy?
- Do you believe that combination will be good for commercial real estate demand?
- Do you believe competition for assets will increase?
In addition to answering the above questions, Chang suggested that investors keep an eye on the longer-term outlook.
Article courtesy of Amy Wolff Sorter of connectcre.com.
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