Federal Reserve interest rate cuts may provide some relief for the commercial real estate sector, yet investors are advised to proceed with caution as they consider market opportunities. According to Wells Fargo, the central bank’s half-point rate reduction last month signifies the potential conclusion of the most severe commercial real estate downturn since the Global Financial Crisis. Senior economist Charlie Dougherty mentioned that while lower interest rates are not a cure-all, a more accommodating monetary policy can help set the stage for recovery in the commercial real estate market. He noted that reduced long-term interest rates appear to be easing the pressure on cap rates and are slowing property valuation declines, while improved expectations for an economic soft landing seem to encourage capital re-entry into the market.
Nevertheless, there are challenges ahead. As of Monday, the yield on the 10-year Treasury rose above 4% for the first time since August, following an unexpectedly strong jobs report. Bond yields move inversely to prices, and a single basis point represents 0.01%. The CME FedWatch Tool indicates an approximately 84% chance of a quarter-point rate cut at the Federal Reserve’s November meeting, with no expectation for another half-point cut. Dougherty also highlighted the various hurdles facing the market, particularly for office spaces. Despite this, he believes that lowered interest rates could help mitigate distress and reduce upcoming challenges.
Douglas Gimple, senior portfolio specialist at Diamond Hill, stated that companies could find some relief and eventually refinance at lower rates, having previously extended mortgage deals in a higher-rate environment. His firm’s Short Duration Securitized Bond Fund had about 25% of its portfolio in non-agency commercial mortgage-backed securities as of the end of September. While acknowledging that interest rate cuts are not an instant solution, Gimple suggests investors adopt a bottom-up approach to identify valuable opportunities amid pricing pressures linked to commercial real estate.
Investors should be informed about their managers’ purchases or, if investing independently, understand their acquisitions. Gimple expresses particular interest in single-asset, single-borrower commercial mortgage-backed securities (CMBS) and commercial real estate collateralized loan obligations. He prefers investments dependent on specific deals, avoiding office spaces in Los Angeles or New York while considering suburban deals. He is interested in class A office buildings, “trophy” hotel properties in desirable locations, single-family rentals, industrial properties, and somewhat in retail. Gimple advises that CMBS holdings be a component of a diversified fixed-income portfolio that includes credit and Treasurys. Ultimately, the risk appetite should dictate the appropriate allocation, as summarized by Gimple’s caution against avoiding whole market segments merely due to headline-driven apprehensions.
