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Why CRE Debt Is Unlikely To Get Much Cheaper In 2025

Bond analysts have a word of advice for commercial real estate owners waiting for the cost of debt to come down significantly: Stop.

The yield on 10-year Treasury bonds, used to benchmark all sorts of real estate debt, has risen roughly 100 basis points since the Federal Reserve began monetary easing in September. The movement reflects broad anxiety among bond traders, and a significant retreat in yields is unlikely without severe economic pain. 

“Unfortunately, the first thing that comes to mind in terms of getting lower long-term rates is probably a recession,” said Zach Griffiths, the head of investment grade and macro strategy at CreditSights, part of Fitch Solutions. “It's hard to envision a scenario that's not a pretty substantially negative economic growth scenario that pushes yields way down from where they are today.”

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It’s a troubling development for some of the commercial real estate developers and landlords that have pushed out loan terms or put off refinancing, expecting a better lending environment to materialize. For many of the owners that extended, the clock is ticking down on the amount of time they can pretend. 

“These projects that are on the higher-leverage side in today's rate environment, it does pose a problem,” said J.C. de Ona, Southeast Florida division president at Centennial Bank. 

The run-up in bond yields in the last quarter of 2024 was driven by concerns over inflation and a shifting outlook among investors on where Fed policy was headed. Longer-term bonds are being sold at a faster pace than bonds with shorter maturity periods, a phenomenon known as a “bear steepening” in Wall Street parlance, which is usually reflective of rising inflationary expectations.

Investors are broadly worried about stubborn inflation, especially after the Fed revised its own projections upward at the last Federal Open Market Committee meeting on Dec. 18, where Fed Chair Jerome Powell announced a 25-basis-point cut to the benchmark federal funds rate but signaled that the pace of relief was likely to slow. 

The Fed’s shift in tone led to sell-offs in stocks and bonds as investors adjusted their portfolios to reflect a higher-for-longer rate environment. Projections of Fed policy have become increasingly conservative as unemployment remains low and inflation elevated above the Fed’s 2% target rate.

Fed data from December suggested there would be only two 25 bps cuts in 2025, a significant departure from the aggressive cuts traders had already priced into markets. 

CreditSights and others now predict that the Fed will not make any rate cuts in 2025, leaving many commercial real estate owners who have been extending loan maturities to delay refinancing amid high rates staring at a 2025 debt landscape that looks much the same as last year.

De Ona, who expects the yield on the 10-year to come down modestly in 2025, has clients who have looked at the volatility in the bond market and opted to sign deals at today’s rates. But owners who had relied on debt service costs to come down are looking at another year with little relief.  

“We're funding a construction project. When we're done, their exit is a Fannie- or Freddie-type of long-term rate, and that hasn't really looked great,” de Ona said. “Some people have moved to lock in rates, and others are a little bit concerned.” 

Extend-and-pretend policies have pushed more loan maturities into 2025, with Gray Capital updating its estimates to show CMBS maturities peaking at $5.4B in October. In all, JLL projects that roughly $1.5T in commercial real estate loans will come due this year.

The key drivers of bond yields throughout 2025 will be adjustments in monetary policy and growth expectations among investors coupled with reassessments of fiscal risk, Griffiths said.

But the inauguration of Donald Trump as the country’s 47th president next week looms over near-term forecasts, with analysts and investors girding for potentially resurgent inflation. 

“We know tax cuts, we know tariffs and we know less regulation are kind of the big three. And all of those things are either inflationary or they're going to spur some sort of growth, especially looking at tax cuts,” said Jack Herr, an investment analyst focused on fixed-income funds at GuideStone. 

“The market's done its best to price in as much as possible,” he said.  

How the maximalist positions Trump staked out on the campaign trail, such as a blanket 10% tariff on all imports, translate into actual policy will have profound economic impacts. But presidents rarely make good on all of their election-season promises, and there are some hopes in financial circles that the start of Trump’s term will bring some clarity to markets.

Reducing market volatility could reduce the risk premium bond investors are demanding and provide nominal relief to borrowers, but the economic impacts of early Trump policies could also deepen investors’ anxiety over long-term U.S. debt prospects, Griffiths said.  

“The market is underappreciating how quickly some of the more market negatives, like tariffs and potentially mass deportation or migration policies that put tightening pressure on the labor market, potentially become inflationary,” he said.

Instead of describing Fed policy, and thus debt costs, as higher-for-longer, this moment could be better described as a return to the mean, Griffiths and Herr said. 

The ultralow interest rate environment of the last decade was a product of the Global Financial Crisis in 2008 and extended by a pandemic that killed more than 7 million people across the world. 

Those earth-changing emergencies necessitated the low borrowing costs fostered by the Fed and reserve banks around the world, the argument went at the time. With the pandemic largely past, so too is the need for rock-bottom rates. 

“I wouldn't expect the 10-year to have any big move down to where we were at before Covid or even at the beginning stages of Covid. We're living in a new reality,” Herr said. “I've kind of given up the dream of a sub-3% mortgage. That's how I approach it, and personally, I think it’d be prudent to do for all investors.”