A commercial building available for rent in Melville, New York, April 17, 2023.
Howard Schnapp | Newsday | Getty Images
The tide could be turning for commercial real estate.
The Federal Reserve began its interest rate cutting cycle in September, lowering the Fed funds rate for the first time since 2020 by 50 basis points, while hinting that more cuts are on the horizon. That could give interest rate-sensitive sectors such as commercial real estate long-awaited positive momentum.
Lower interest rates make debt cheaper, helping to accelerate deal flow in an industry where deal activity had stalled into the second quarter of 2024. The CRE market had been pressured in the years after the initial Covid shutdowns, ending a nearly 15-year bull run in the face of higher borrowing costs, weak tenant demand and increased property supply. As a result, property values and sales declined.
The Fed’s shift in policy is “the most notable green shoot” for the CRE market, Wells Fargo analysts wrote in a Sept. 3 research note. While lower rates are not a “magic bullet,” the easing of the Fed’s monetary policy “lays the groundwork for a commercial real estate recovery,” analysts wrote in a follow-up report in late September.
For higher dividend-paying stocks such as REITs, lower rates make these fixed-income investments more attractive for investors. But the primary impact of interest rate cuts is psychological, according to Alan Todd, head of commercial mortgage-backed security strategy at Bank of America.
“Once the Fed starts to cut, they’ll continue along that path,” which fosters a sense of stability, Todd said. As the market feels more comfortable, it will “incentivize borrowers to get off the sideline and start to transact.”
RentCafe. By the end of 2024, developers are set to complete more than 518,000 rental units.
The multifamily sector was a pandemic darling within CRE as rent growth hit double digits in 2021. But that growth rate has since slowed to around 1%.
Yet this increase in demand suggests a shift in consumer behavior, as “households are taking advantage of greater apartment availability, generous concessions and more manageable rent growth,” Wells Fargo said.
Among the factors pushing renters to multifamily is a lack of affordable single-family homes for entry level. This trend is underscored by the stark contrast between homeownership costs and rental expenses: The average monthly mortgage payment reached $2,248 during the second quarter, 31% higher than the average monthly apartment rent of $1,712, Wells Fargo said.
Multifamily is also benefiting from stabilizing vacancy rates. For the first time in over two years, vacancies didn’t rise during the second quarter, holding steady at 7.8%. This stabilization, combined with the 1.1% average increase in rent, indicates a healthier balance between supply and demand.
Looking ahead, the outlook for the multifamily sector remains positive.
Wells Fargo analysis suggested that “high homeownership costs should continue to support rent demand,” meaning that current trends favoring multifamily housing are likely to persist in the near term.