The Fed FINALLY Cut Interest Rates - What's Next For Real Estate

In a move that virtually everyone in commercial real estate has been waiting for for over a year, the Federal Reserve finally cut interest rates last week by 50 basis points with two more cuts that are projected to happen by the end of the year. And today, the question on everyone's mind is now that these rate cuts are actually in motion, how are these going to affect the commercial real estate markets aside from just short term borrowing costs starting to come down? So in this video, I want to walk through three of the biggest impacts that interest rates could have on the real estate industry throughout the rest of this year and into 2025 and how this might impact you if you're looking to break into commercial real estate as soon as possible. So the first thing worth noting is that even though a 50 basis point rate cut is clearly a sign of things moving in a positive direction, this interest rate cut itself isn't doing much to impact borrowing costs today. Because the financial markets were expecting this rate cut for several months before it actually ended up happening, this change in the federal funds rate was already priced into the U.S. Treasury market before September 18th, and the 10-year Treasury yield, which is typically used as the index for long-term fixed-rate commercial real estate loans, has actually stayed relatively steady since this rate cut was made. And with the next several rate cuts that are projected to happen at the next two Fed meetings also having been priced into today's Treasury rates already, even if we do see two more rate cuts over the next few months, it's relatively unlikely that U.S. Treasury rates will go down substantially before the end of the year. Now with that all said, one thing that could help commercial real estate borrowers in the short term right now is the additional level of certainty in the market that interest rates have peaked now that that first rate cut has actually happened, which has already helped decrease spreads in the market or the additional yield that lenders charge above an index rate like the 10-year Treasury, with all-in interest rates on some loans today coming in in the low fives and even the high fours. This rate cut and future rate cuts will also have a much more immediate impact on the one-month SOFR, which is the index rate used on most floating-rate commercial real estate loans in the U.S., but even with a 50-basis point cut bringing the Fed funds rate down to 4.75% to 5% last week and two more expected cuts in 2024 that could bring this down much closer to 4% with spreads on these loans coming in at roughly 250-400 basis points in most cases, we still may see all-in interest rates on these loans in the high six, seven, or even 8% range. Ultimately, in the long term, interest rate cuts will have a positive effect on borrowing costs for virtually all loan types in commercial real estate, but these effects may ultimately take a while to trickle down through the market. The second thing to note about these interest rate changes is that interest rate cuts are typically spurred by signs of a weakening economy overall, which could have negative effects on rents and valuations of commercial real estate, even as borrowing costs decrease. Today, companies are dealing with the highest borrowing costs we've seen since 2007, making it extremely difficult to expand or even sustain their current payroll, and as a result of this, we've seen the U.S. unemployment rate gradually tick up over the last two years from 3.6% in August of 2022 to 4.2% in August of 2024. And even though rate cuts are intended to encourage lending activity and ultimately economic growth, in the six rate cutting cycles we've seen since 1990, the U.S. unemployment rate was on average 1.4% higher one year after the Fed started cutting rates, with interest rate decreases usually happening after the economy has already shown signs of distress. And while the Fed continues to say that the U.S. economy is in good shape, these moves are typically done by a Federal Reserve that wants to change the trajectory of where the economy is headed, and if unemployment continues to move upward more quickly before the effects of rate cuts can start to hit the market, this could have some pretty significant impacts on the real estate industry. The unemployment rate affects virtually every sector of commercial real estate, since fewer jobs can lead to less consumer spending both online and in stores, less disposable income for people to spend on housing, and even less employer demand to lease vacant office space than we're seeing in the market today. And this potential slowdown in demand is coming at a time when new deliveries are still at record highs in some sectors of the market, which could add additional downward pressure on rents, even as borrowing costs continue to go down. Now the last thing I want to mention about these changes in interest rates is that now with the market feeling confident that interest rates are finally headed in the right direction, transaction activity in commercial real estate should finally start to pick back up. As of September of 2024, there was $382 billion of dry powder looking to be deployed into commercial real estate, which means that once borrowing costs end up getting to a point where deals start to pencil again, that bid-ask spread between buyers and sellers in the market is going to start to narrow in a very big way. And even with investors just anticipating rate cuts starting earlier this year, according to Cushman & Wakefield, investment sales activity already started to turn around in the first half of 2024 before any rate cuts were made, with a 3.5% increase in year-over-year sales activity in Q2, up from a 12% decrease in year-over-year sales activity in Q1, and up from a 50% decrease in year-over-year transaction volume from 2022 to 2023. And with more commercial real estate sales activity creating bigger workloads for real estate investment, brokerage, and lending firms, many of which have substantially reduced their headcounts over the last few years, this could lead to a significant rise in job openings among some of the most popular roles within this industry. Titles like acquisitions analyst, investment sales analyst, and debt and equity placement analyst would all fall into this category, with these jobs all having a focus on the purchase, sale, or capitalization of real estate deals, and if you're about to graduate in 2025 and looking to land one of these jobs, this could be a sweet spot when it comes to hiring timing. In commercial real estate, bonuses can be a significant portion of total compensation, and to earn these bonuses, employees of commercial real estate firms will typically need to stick around until January, February, or March of the following year. And this means that a lot of industry professionals that are about to accept a new job will end up waiting to leave their current role until between about February and April of the calendar year, which could also increase the number of opportunities for new college grads that would be able to start in the spring. And if you're watching this and you're already working in the real estate industry, another thing to remember is that the vast majority of commercial real estate firms rely on transaction volume to generate revenue, which means that increased sales activity could lead to bigger salary increases internally, higher bonus potential if you hit certain performance targets, or even more opportunities for fee participation at small to mid-sized firms. Ultimately, while rate cuts are good news overall for commercial real estate investors, these are three things to think about as these cuts are made, and if you want to make sure you're ready for potential job opportunities that might come up as a result of these changes, and you want to be able to pass an Excel modeling exam that might be given to you during the interview process at commercial real estate firms, make sure to check out our all-in-one membership training platform, Breaking the CRE Academy. A membership to the academy will give you instant access to over 120 hours of video training on real estate financial modeling and analysis. You'll get access to hundreds of practice Excel interview exam questions, sample acquisition case studies, and you'll also get access to the Breaking the CRE Analyst Certification Exam, which covers topics like real estate pro forma and development modeling, commercial real estate lease modeling, equity waterfall modeling, and many other real estate financial analysis concepts that will help you prove to employers that you have what it takes to tackle the responsibilities of an analyst or associate at a top real estate firm. If you liked this video and want to see more content on the channel on current market events, make sure to hit the like button to let me know, and let me know in the comments how you think these interest rate cuts are going to end up impacting the market over the next 6-12 months. As always, thanks so much for watching guys, I hope you found this helpful, subscribe to the channel if you haven't already to see more videos like this every single week, and I'll see you in the next video.