Wells Fargo Chief Economist: CRE Can Rebound On A Single Rate Cut, But Lending Will Be Slower To Move

While the commercial real estate industry is expected to ramp up activity both before and after a highly anticipated rate cut by the Federal Reserve this month, lenders may not budge much —  and the impact of the first rate cut in more than four years could be mostly psychological, according to one prominent economist.

Yet that alone could spark activity even if lenders don’t immediately respond.

Last week, Federal Reserve Chairman Jerome Powell said the “time has come,” for interest rates to come down from their highest levels in two decades of between 5.25% and 5.5%. Many economists are predicting at least a 25 basis point reduction.

Wells Fargo Senior Economist Charles Dougherty is optimistic the cut could be as high as 50 bps. Wells Fargo estimates that will be followed by more cuts in November and December.

For lenders, a September cut, the first in what is expected to be several decreases by the end of the year, may help only “around the margins,” Dougherty said, adding that capital markets  are “going to be prudent, but less guarded as the Fed cuts rates and anticipated soft landing is achieved.” 

But as the nation’s bank works to balance policy against a recession or other strong declines in the economy, something Powell’s Fed has tried to avoid for more than two years, a cut will signal emergence from one of commercial real estate’s worst chapters for CRE.

Dougherty said just the anticipation of a cut is greasing wheels.

“If you're trying to think about not just the next couple months, [but] for the next couple of years, it seems like we’re turning the page on a very difficult environment for the commercial real estate industry,” he said. 

“What's more important, I think, is what you can think of as the announcement effect, or the higher expectations for rate cuts moving forward, meaning the era of tight monetary policy is coming to an end. So I think that can have a positive impact on confidence and sentiment within the industry. It can signal to commercial real estate investors that interest rates are going to move lower. And if you look at the macroeconomic backdrop, it's increasingly likely that we do get a soft landing. So you have some of these stars starting to align.” 

During the first quarter of 2024, commercial real estate transaction volume totaled $78.9B, down 16% from the same period a year earlier, Wells Fargo reported. 

“There's been a lot of capital on the sidelines, and it doesn't want to stay on the sidelines forever,” Dougherty said. 

Zooming out, certain asset classes are likely to recover sooner once rates are cut, he noted. Multifamily and industrial properties are primed for a rebound over the course of the next few rounds of rate cuts and could eke out some lending for it.

“Even that small of a decrease should provide some improvement, especially when you kind of look at the amount of loan maturities that are set to come due this year next,” Dougherty said. “So any little bit helps be a panacea.”

Dougherty pointed to existing positive trends in lending, including the rise in commercial-backed mortgage originations, which rose 27% over the prior quarter. Though CMBS-backed debt only makes up about 13% of the total lending landscape, he said, any uptick “shows me that there are some sort of green shoots that are sprouting,” Dougherty said.

Those shoots don’t spread to Wells Fargo itself. The company has sold off billions of dollars of CMBS loans, handing over its entire division to a service provider called Trimont amid ongoing pressure in the U.S. banking industry, ASD Zeitung reported last week. 

Smaller banking providers might prove the most nimble moving forward, according to data cited by the Harvard Business Review last week.

Among CRE loan delinquencies exceeding 90 days, issues have surged from less than 1% in mid-2022 to 3% by the start of this year for the largest banks, according to calculations by the Conference Board using FDIC reporting. Meanwhile, delinquency rates for all other banks are hovering around 1%.

The best way to move the needle is for markets to adjust to a new reality, Dougherty said on the cumulative impact of rate reductions.

“As the Federal Reserve does start the process of shifting monetary policy from restrictive meaning and holding back economic growth towards neutral meaning, they're aiming to not have any impact whatsoever,” he said. “That should help economic growth and, by extension, demand for commercial real estate.”