By Ryan McDonald, Advisor
SVN Commercial Advisory Group
Priority of reducing inflation likely to push any cuts further into the future
The question on a lot of minds in commercial real estate right now is whether the Fed will be pressured to cut interest rates in 2024. A second question is whether there should be a rate cut, regardless of that pressure.
FOMC Meeting in March 2024
The Federal Open Market Community (FOMC), which met on March 20, didn’t provide many clear-cut answers to such questions. The FOMC did confirm its policy to keep rates ranging between 5.25% to 5.5% – the fifth straight meeting in which the Fed has chosen to keep rates in place. Jerome Powell, Chair of the Federal Reserve of the United States, says he is keeping a close eye on the inflation and the labor markets, which have not seen the inflation rate dip to the target of 2%.
Lending Issues
Still, we’re left wondering about the timing and significance of rate cuts as 2024 wears on.
To help answer questions about any upcoming cuts, it’s important first to look at the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) report for January 2024. Derived from a survey of senior loan officers at major banks and other financial institutions, the SLOOS Report reveals higher lending and credit across the board for the entire year.
Those findings run counter to the Fed’s goal which, along with raising the overnight rate, is to get banks to start tightening their credit and lending. This has been Chairman Powell’s express policy.
Lower Prices Under Tight Lending
Tighter lending and higher rates have direct effect on CRE values. When is costs more to borrow money for a commercial property, we see a dampening of prices. That’s because the demand for such property drops under these conditions. Also, economic activity in general can become more sluggish, making CRE property less attractive.
Current credit tightening is nearing what it was in the financial meltdown in 2008-2009.
CRE Debt Maturing
And there’s another looming concern. CRE debt is currently at about $2.7 trillion. A sizable chunk of that debt, $659 billion, is maturing. Many asset holders will be refinancing, but what happens if a tight lending market makes that impossible? Will investors lose the properties? Or be forced to sell at a loss? These are all legitimate worries that, if they come to fruition, could have far-reaching consequences for the CRE market and economy at large.
Banks are already preparing for this eventuality by settling hundreds of million to the side. That means they’re already taking losses on CRE debt as they brace for defaults. Bank of America, for example, suffered unrealized losses of about $98 billion on a portfolio of held-to-maturity securities of $594.5 billion. That’s down from even higher losses in the third quarter: more than $131 billion on a portfolio of $603 billion. But concerns here are real.
The question of the Fed’s timing…
So, what’s the answer to the rate question? Should the Fed cut them in the near future? My answer is no, because we need to arrive at that 2% inflation target first. Having sad that, it’s likely the Fed will have choice but to cut them sooner rather than later. The amount of outstanding adjustable-rate debt could have major impacts across the board if rapid-fire defaults begin.
Powell has already indicated that a March cut was unlikely to happen. The betting markets at year end 2023 were pointing to four to five rate cuts for 2024. With seven more FOMC meetings to go for 2024, it’s looking as if May might be the earliest starting point for a cut.
Some experts predict that cuts will come much later. Torsten Slok, Apollo Management Chief Economist, maintains that the Fed will spend the remainder of this year battling inflation and will not cut rates.
In light of such analysis, I don’t believe we will see a drastic decrease in the overnight rate in 2024. We may be on target for around 4% by year’s end. That’s only a 1-1.5% cut over the duration of the year.
So, stay tuned. We’ll all have to wait and see what the Fed does. Whatever it is, it will likely have significants implications for the CRE market.
Ryan McDonald is an advisor for SVN Commercial Advisory Group. Reach him at (941) 487-6989 or ryan.mcdonald@svn.com.