What the Fed’s latest rate hike means for commercial real estate

Dealmakers optimistic about smaller increase, but warn that distress looms regardless

Investment Sales, Federal Reserve, Interest Rates, Real Estate Finance, Jay Powell
Jerome Powell (Getty)

The quarter-point increase brings rates to a target range of 4.5 to 4.75 percent, the highest they’ve been since 2007. The Fed said in a statement that it expects “ongoing increases” as needed, but hinted that future rate hikes are unlikely to be as steep as those seen last year.

For commercial real estate firms in an investment sales market that’s been encumbered by high rates for months, this seemingly tempered approach is cause for optimism.

Marcus & Millichap’s John Chang, who called the quarter-point increase “a positive sign,” believes investment sales could kick back up in the second half of the year. Even if rates keep rising, smaller hikes will give investors the confidence they need to underwrite and close deals.

“Investors will need to navigate a price discovery process in the new interest rate climate with less aggressive performance growth forecasts, but there is a lot of capital waiting to enter the market,” he said.

CBRE’s Darin Mellott said this week’s Fed action is “sort of light at the end of the tunnel,” predicting more traction in the second quarter and a “broader recovery” for the commercial real estate market in the second half of the year.

“Now the markets are gonna say, ‘Look, we think that we’ve hit the peak Fed funds rate or we’re very close to it now,’” he said. “So then you get a little bit more certainty around interest rates and people can start to underwrite a bit more confidently in that kind of an environment.”

Others were more cautiously optimistic. Savills’ David Heller said the less dramatic increase is “helpful,” but cautioned that much depends on the Fed’s actions in the coming months and how lenders and the broader economy respond.

“Some of it’s going to be pressure prompted by lenders who will come to the position of, ‘Listen, we’ve got to do something here. We cannot just continue to push this along.’” he said. “It really also depends heavily on what’s going on in the overall economic environment.”

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JLL’s Bob Knakal said that the Fed should stop raising rates altogether to bring down the cost of borrowing and enable more property sales.

“The dynamics within any marketplace is always a battle between fear and greed, and fear is winning,” Knakal said. “That’s a problem. We need more confidence to come back into the market for all participants. And once that happens, I think things will start to feel better.”

Knakal is hopeful that deal flow will start gaining momentum in the second quarter, but said there’s still often a gap between what sellers believe the market can bear and what buyers can actually pay.

“There are people making moves today,” Knakal said. “It takes the psychology of the seller a while to catch up to a new reality.”

As interest rates continue to climb and the cost of rate caps soars, many borrowers with maturing loans will have no choice but to sell their properties, which could allow deal flow to pick up.

Mellott believes that most of the distress will be concentrated around Class B and C office buildings, though Knakal believes no asset class will be spared.

“People are not going to be able to refi for the same amount that they had,” Knakal said. “I think that given the opaqueness of the market today, a majority of owners that I’ve spoken to so far have been reluctant to put fresh capital into effectuating the refi, and we’ll see how that plays out over time.”

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