Rate Relief Has Been Limited, But Rising Values Bring Some Investors Back To CRE Anyway

Commercial property owners got what they wanted in September in the form of a 50-basis-point interest rate cut, courtesy of the Federal Reserve. But despite the long-awaited reduction in the base rate, long-term commercial borrowing rates are up, keeping the brakes on the market's rebound. 

Home mortgage rates are rising and commercial debt rates are stagnant, hovering around 4% at the end of October. 

Investors are split on whether now is the time to enter the market, torn between market fundamentals like capitalization rates that have started to compress in some asset classes and a rate cut that hasn't trickled into commercial debt underwriting.

“We haven't seen [long-term rates] move because people don't really know where the economy is going,” said Holly MacDonald-Korth, CEO of Miami-based middle-market lender KDM Financial. “There's not a consensus that we're going to be in a recession that's going to cause rates to go lower. I guess we kind of think we're going to continue to boom.” 

Some investors aren’t waiting for rate relief to make its way to borrowers and are lining up deals now to avoid letting rising values from a market recovery eat away at any debt coverage savings. 

Debt origination reached $244B in the third quarter nationally, according to Avison Young, up 80% compared to the first half of the year. CBRE announced this week that its revenue from investment sales jumped 22% in the third quarter compared to last year.  

The yield on five- and 10-year Treasury securities, a benchmark for commercial loans of a similar length, was trending down ahead of the Fed’s first rate cut as investors priced in what they expected to be an aggressive pace of relief moving through 2025. 

But positive economic news since the September Fed meeting has led investors to question how fast Chair Jerome Powell and the Federal Open Market Committee will move to cut rates, leading investors to pile back into long-term bonds.

“The [bond] market was being very exuberant prior to the Fed interest rate cut,” said Nick Villa, an economist on Moody's real estate team. “Maybe they were a little bit aggressive in the recalibration of that, but they're starting to get more stability relative to a year ago.” 

The net effect has muted the impact of the Fed’s rate cut on long-term debt underwriting as the bond market searches for equilibrium after what has been its longest-ever yield curve inversion. These inversions occur when the return on long-term debt is lower than what an investor can get from short-term debt, a historic indicator of an impending recession.

The 10-year Treasury yield was 4.2% on Thursday and has been above 4% for nearly the entire year, up from roughly 0.8% this time in 2020. Five-year Treasurys were trading at 4% on Tuesday and have been priced above 3% since August 2022.

John Buran, CEO of New York's Flushing Bank, said there was room for growth in the long-term bond market, which could add more upward pressure on commercial real estate debt underwriting. 

Recession fears have faded — the U.S. is at a 15% risk of a recession in October, according to Goldman Sachs — and expectations that the Fed is approaching its fabled soft landing could provide more tailwinds to the long-term debt market, Buran said. 

“When people feel more confident, they want to borrow. More potential borrowers flooding the market can cause the price of money to move up,” he said. “Meanwhile, hopefully, the Fed is continuing to move the shorter-term price of money down.”

There is still a large number of investors waiting for the Fed to make further cuts, which analysts and executives expect to lead to a steady increase in deal flow over the next several years rather than a deluge of new activity. 

Banks still haven’t returned in force to the commercial real estate market, in part because they are facing regulatory scrutiny over the health of their loan portfolios, and the gap is being filled by private lenders whose investors demand a higher premium. 

While Flushing Bank saw its pipeline of transactions start to grow in June, Buran said the uptick was still well behind where deal volume had been before the Fed began to raise rates in March 2022.

“Dollarwise, it's really not at the levels where we’re used to seeing economic activity,” he said. 

MacDonald-Korth has had existing clients turn down term sheets that would have brought their floating interest rates to single digits because the borrowers are holding out for deeper cuts. The November and December Fed meetings will offer Powell an opportunity to inject more stability into the market, MacDonald-Korth said.

“If the Fed continues its rate cut at 25 basis points a meeting pretty steadily, which is what they typically do, then that removes some volatility from the market, and we have a horizon or a floor of where we think rates are going to be,” she said. “That gives everybody more confidence about values and more confidence to transact.” 

MacDonald-Korth is among the Fed watchers expecting a quarter-point cut at each of the Fed’s two remaining meetings this year, but it is far from a foregone conclusion. Moody’s is forecasting that the Fed will cut 25 basis points in November but keep rates flat in December, Villa said. 

The Fed is navigating monetary policy against the backdrop of a presidential election and wars in the Middle East and Europe, and Moody’s economists don’t expect long-term rates to start stabilizing until the end of 2026. 

“There's a lot of cuts priced in over the next two years, but in our forecast, we think we're going to be at the neutral rate of interest of around 3% in the first half of 2026,” he said, with the 10-year bond rate settling in around 120 basis points above the benchmark rate.

The goal for investors today is to find the ideal moment to get into the market, balancing the cost of debt against valuations, which are recovering in some sectors after taking a beating in recent years.

There is consensus that the Fed has pivoted and rates will come down, but debate rages on about the pace of those cuts and where interest rates ultimately settle, and the recent run-up of long-term bond yields reflects the market recalibrating when that rate relief will come.  

“Things are just taking a little bit longer,” Villa said. “The economy just continues to do so well. It continues to defy expectations.”