4 min read
Key takeaways
- The Federal Open Market Committee (FOMC) kept the federal funds target rate between 5.25% and 5.50%
- Interest rates may be turning a corner. Federal Chairman Jerome Powell said “the policy rate is likely at or near its peak for this tightening cycle.”
- Multifamily investors should look at multiple economic and business factors as they consider real estate hedging options.
The ongoing saga of interest rates continues.
The Federal Open Market Committee (FOMC) held interest rates steady for the third consecutive meeting, keeping the target range for the federal-funds rate at 5.25%-5.50%.
“While it will still take a while to bring inflation to its long term 2% target, the Fed now appears ready to pivot and to begin lowering the Fed funds target range during 2024,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at JPMorgan Chase.
Here are a few things to keep in mind about the rate environment.
Interest rates may have turned a corner
As recently as December 8, Chairman Powell said “it would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease.”
But at the conclusion of the December 13 FOMC meeting, Powell said “the policy rate is likely at or near its peak for this tightening cycle.” The new round of quarterly economic projections envisions 75 bps worth of Fed rate cuts during 2024, another 100 bps forecasted for 2025 and another 75 bps for 2026. Powell took pains to caution that the Fed will monitor inflation and the economy closely and tighten further if necessary.
“Treasury yields had been extremely volatile throughout the fourth quarter,” Kraft said. “The five-year peaked at 4.96% in mid-October and was down to around 4.20% shortly before FOMC. The market had been continually reassessing how much and how quickly the Fed might lower rates in 2024, following a period when the mantra was ‘higher for longer.’”
Although inflation seemed to be heading in the right direction, there were some preliminary indications that the job market might be cooling off, Kraft said. “A higher nonfarm payroll in November created some doubt as to whether the Fed would change its stance,” he said. “But those doubts were blown away at the December meeting.”
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 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
“Pressures on the commercial real estate sector are likely to intensify,” wrote Ginger Chambless, Head of Research for Commercial Banking at JPMorgan Chase in her 2024 economic outlook. “With nearly $550 billion of maturing commercial real estate debt over the next year, losses are expected to mount for lenders and investors,” she said. “Reduced lending activity and potential investor losses could be an economic headwind.”
It's important to note that underlying fundamentals vary significantly across asset classes.
- Demand for affordable multifamily properties remains elevated, while there’s some downward cyclical pressure on luxury properties.
- Industrial real estate is 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.
- Office faces challenges due to changes in working patterns, including remote and hybrid work.
Typically, interest rates decrease in a recessionary environment. How quickly rates drop and to what degree depends on how high inflation is running and the severity of an economic slowdown. Lower interest rates could benefit commercial real estate values in the long term. “But in the near term, values could be hurt by a pull back in business and consumer spending activity,” Chambless said.
Hedging interest rates
Amid economic uncertainty, real estate investors may consider hedging options. Before you decide to hedge against interest rates, you should:
- Understand your business’s cash flow
- Assess the interest rate sensitivity of your revenues and expenses
Economic factors influencing interest rates
While interest rates have a unique influence on commercial real estate, it’s important to look at multiple economic factors, including:
- Labor markets: In recent months, the labor market showed signs of cooling off. While growth in nonfarm payrolls—199,000—was ahead of economists’ forecasts for November, the level of hiring was below the monthly average of 240,000 jobs added in the last 12 months.
- Inflation: Inflation has eased over the past year but remains elevated, according to the FOMC press release. During his post-meeting press conference, Chairman Powell reiterated the Fed’s commitment to reducing inflation to 2% while acknowledging that—assuming inflation continues to moderate—tightening may have peaked.
- 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.
In an uncertain interest rate environment, it’s important to examine the specifics of your local multifamily real estate market.
