Continued treasury volatility

“The bond market craves certainty and stability. Instead, it has had to deal with uncertainty and chaos over the last several months,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at J.P. Morgan. 

“The on-again, off-again status of tariffs—whether imposed, postponed or merely threatened—makes it difficult for analysts and the market to form a satisfactory view of the economy’s evolution and the level of future inflation. That is felt most acutely in the realm of medium- and long-term Treasury yields,” he said.

How the Fed affects short- and long-term interest rates

As always, it’s important to differentiate between short- and long-term interest rates and how the Fed’s actions impact each.

• Short-term interest rates are directly impacted by the Federal Reserve. As the Fed’s primary tool for influencing interest rates and the economy, the federal funds target range directly drives other short-term market rates such as prime and SOFR.
• Medium- and long-term interest rates—such as yields on Treasury notes and bonds, interest rate swaps and corporate bonds—can be influenced by the Fed but ultimately depend on the market’s long-term expectations of inflation and the direction of the economy. From day to day, supply and demand can also drive these rates. Because the collective view of the market is outside of anyone’s control and can be driven by many factors, long-term rates are more difficult to forecast and—particularly in the current market environment—can exhibit considerable volatility.

What future interest rates could mean for commercial real estate

“If inflation remains tame and the labor market softens, the Fed’s economic projections indicate that they foresee the need to lower rates twice in 2025,” Kraft said. As of July 3, Fed funds futures imply a 70% chance of a rate cut at the September FOMC meeting, and another one by year end.

“The concern is that both tariffs and fiscal policy may be inflationary which—if severe enough—could delay accommodative action by the Fed,” Kraft said. 

The cost of tariffs could be passed to producers and consumers in the form of higher prices, causing measures of inflation to rise. “Higher inflation would likely result in stable to higher interest rates as the FOMC might deem it appropriate to stay on pause for longer or hike interest rates to curb inflation,” Chambless said.

“Higher inflation would likely result in stable to higher interest rates as the FOMC might deem it appropriate to stay on pause for longer,” Chambless said.

• Demand for affordable multifamily properties remains elevated, while there’s some downward cyclical pressure on luxury properties.
• Industrial real estate is beginning to normalize, but still experiencing tailwinds related to domestic manufacturing capacity and infrastructure investments to meet customers’ on-demand expectations.
• Retail performance has been mixed depending on location and concept. Neighborhood shopping centers continue to perform well.
• Office is starting to show signs of normalization. As more employees return to the office full time a flight to quality is possible.

The possibility of a recession

A recession could have wide-ranging impacts on multifamily and other commercial real estate assets. An economic downturn could also impact interest rates. 

“Typically, interest rates decrease in a recessionary environment,” Chambless said. “How quickly rates drop and to what degree depends on how high inflation is running and the severity of an economic slowdown." 

“In the event of stagflation—a recession accompanied by higher prices—the situation becomes more complex, and creates more challenges for decision-making by the Fed,” Kraft said.

The Fed would ultimately need to decide at the time which risk—higher inflation or lower employment—demands their immediate attention.

While interest rates have a unique influence on commercial real estate, it’s important to look at multiple economic factors, including:

• Labor markets: Labor markets remain steady. Total nonfarm payroll employment increased by 147,000 in June. The unemployment rate changed little at 4.1%, according to the U.S. Bureau of Labor Statistics.
• Inflation: Inflation progress has stalled in recent months. As of May, the Personal Consumption Expenditures (PCE) price index increased 0.1 percent from the previous month. Excluding food and energy, the PCE price index increased 0.2 percent. The PCE price index increased 2.3% from May 2024. Excluding food and energy—the Fed’s preferred inflation index—the PCE price index increased 2.7%.
• Commercial mortgage rates: Treasury yields can impact hybrid- and fixed-rate loan pricing for commercial real estate investments. Rising yields may reflect higher levels of expected inflation in the long term, while falling yields could indicate lower inflation and a possible slowdown or recession.

It’s also important to consider factors specific to commercial real estate, such as location, asset class and cap rates, as well as demographic shifts and supply and demand.