Wednesday’s announcement of a Federal Reserve interest rate cut came as no surprise to a market that has been waiting impatiently for relief from the “higher for longer” rate environment. But the shifting of gears via a big 50-basis-point drop has some wondering if the Fed waited too long to start lowering rates.
The rate-hiking cycle that preceded the Sept. 18 cut was the most aggressive the U.S. economy has seen in more than 40 years, and the federal funds rate has been holding at its cyclical peak of 5.25% to 5.5% since July 2023. The Federal Open Market Committee said it expects to make two additional cuts this year, with scheduled meetings in November and December. And there will be ample opportunity for cuts in 2025 with eight scheduled meetings on the calendar.
However, the Fed also has said that it is going to keep a close watch on economic data to guide future policy moves. “We know that it is time to recalibrate our policy to something that is more appropriate given the progress on inflation and on employment moving to a more sustainable level,” said Fed Chair Jerome Powell. He also said the FOMC is at the beginning of the process of moving toward a sense of neutral, and that it will “move as fast or as slow as we think is appropriate.”
Pace of Future Rate Cuts Remains Uncertain
The 50-basis-point cut to the federal funds rate is welcome news to the commercial real estate market, following months of anticipation. Yet this first rate cut could create more of a “psychological” impact than a tangible one across the U.S. commercial real estate market, and the path forward is uncertain, according to Altus Group.
“While tremendous progress has been made in bringing inflation down since it reached its peak in the summer of 2022, the most recent inflation data have shown more mixed signals and a general slowing pace of disinflation,” said Altus Group research director Omar Eltorai. “This complicates the expected path forward for interest rate cuts.”
Additionally, recent data suggests some concerning trends emerging around consumer spending. Altus cited reports from Citi that U.S. consumers are shifting their spending away from discretionary goods to focus on necessities, a trend that typically materializes during recessionary periods. Although it appears that the U.S. economy is still headed for a soft landing, the direction of the economy will continue to play out over the coming quarters, added Eltorai.
The latest outlook from CBRE is that the Fed will reduce the federal funds rate by an additional 25 basis points in each November and December, followed by 125 basis points next year. In addition, the 10-year Treasury yield likely will remain under 4% at year-end and be in the mid-3% range for most of 2025 as the Fed eases monetary policy.
Lower Rates Expected to Spur Transaction Activity
CBRE expects rate cuts to have a positive impact on investment sales, forecasting a slight, 5% increase in annual investment activity this year and further acceleration next year. The company also stated: “The forthcoming rate cuts, coupled with lower bond yields, will bolster commercial real estate investment activity and asset values. Despite slowing job growth, we expect the economy will avoid a recession and a soft landing will buoy occupier confidence, resulting in resilient demand for space across all commercial property types.”
Investment sales activity is already picking up on the specter of interest rate cuts. “We have seen spreads reduce and transaction volume picking up, after quarters of pent-up supply,” said Joe Brady, a commercial real estate expert and author and a former head of real estate at Walgreens. Development also will feel less friction, spurring net new growth in retail and multifamily. “Retail, particularly food-and-beverage retailers, are looking to grow rapidly, and the lower-interest rate environment provides lower rents.”
However, lower rates won’t be a panacea. Construction costs remain high, and functionally obsolete properties will continue to struggle to remain viable.
Rate Cuts Benefit REITs
Public REITs already are benefiting from anticipated rate cuts, and CenterSquare forecasts a REIT revival in which listed REITs outperform privately owned real estate over the next three years by a nearly two-to-one margin. Historical data on average three-year total returns following a first rate cut in prior cycles shows that real estate owned by public companies outperforms, returning an average 30.9% compared with 14.5% for real estate owned by private interests.
“Given the interest rate sensitivity of the real estate asset class, it’s no surprise that the aggressive, inflation-fighting monetary tightening around the world has been a drag on real estate performance across public and private markets,” according to CenterSquare senior investment strategist and global environmental, social and governance lead Uma Moriarity. “However, interest rate cuts have historically been a catalyst for REIT performance, especially when compared to private real estate.”
Retail Market Impact
Rate cuts are a sign the Fed is comfortable that inflation is under control and is falling in line with its target. Inflation eased to 2.5% in August, the lowest in more than three years. “The reduction of interest rates will help create opportunities for operating companies and more one-off acquisitions,” said Stenn Parton, founder and CEO of Prism Places, a commercial real estate management and investment firm with $2.5 billion in assets under management. “Because of this, the CRE market will become very aggressive in 2025 and 2026.”
As holiday sales approach, many retailers hope lower interest rates will boost consumer confidence. Mastercard released a new forecast that projects that U.S. retail sales will rise a modest 3.2% this holiday season. According to Reuters, the credit card company also expects retailers to work harder to attract shoppers during a shorter-than-usual shopping season in which Black Friday falls on Nov. 29.
“As a retail platform with a close pulse on the consumer, we welcome the Fed's decision, as the consumer has been hit hard by both inflation and higher interest rates for some time now, which is a rare combination,” said Ryan Moore, co-founder and CEO of Last Mile Investments, a North American Properties company. “We are glad to see both going in the right direction now. The U.S. consumer has been resilient throughout it though, especially in our focus strategies of essential service and F&B, and this will only further bolster that strength as their everyday capital costs decline.”
Dave Cheatham, president of X Team Retail Advisors and of Velocity Retail Group noted: “The market has known an interest rate decrease was coming for a while, just not how much. That means it was already baked into the market, so the effect is lessened slightly. Consumer confidence will improve because the decrease signals rates are not going higher, and consumers will view it as a shift in the right direction. The interest rate drop will likely have a marginal impact on cap rates. One of the offsetting impacts of the interest rate decrease is that everyone expected it, and it certainly will be used in the election cycle narrative.”
Consumers Are Spending Cautiously
“Though far from alarming, today’s data shows consumers spending cautiously,” said ICSC research manager Matthew Panfel. U.S. retail and food services sales excluding gas and auto grew 3.3% year over year in August, according to seasonally adjusted advance data from the U.S. Census Bureau. That’s the same as in July. Such sales grew 0.2% from July to August, slower than the 0.4% growth the previous month. “On the one hand, the August uptick in sales indicates that the economy remains on solid footing as consumers demonstrate they are still capable of spending despite the cumulative impact of elevated inflation and higher interest rates,” he said. “However, sales growth is decelerating, with several retail segments showing declines from last month and spending on dining remaining flat.” Sales at U.S. restaurants and drinking establishments grew 2.7% year over year in August, the slowest growth all year. Such sales were flat from July to August.
—Amanda Metcalf
More Inspiring Leaders
Two weeks ago, C+CT shared ICSC members featured in Connect CRE’s Inspiring Leaders in Our Changing Industry. Connect CRE has added three more: BH Properties president Jim Brooks, Marcus & Millichap president and CEO Hessam Nadji and Colliers Real Estate Management Services U.S. president Karen Whitt, who also is 2024 president of CREW Network. Check out the updated list.
By Beth Mattson-Teig
Contributor, Commerce + Communities Today