It’s no secret that the CRE sector has faced mounting pressure as interest rates rose sharply in recent years. These increases were aimed at curbing inflation, but they have led to higher borrowing costs and tighter lending standards for real estate investors. With borrowing expenses climbing, many property owners—especially those in sectors hit hard by the pandemic, such as office spaces—have found it challenging to maintain profitability and refinance existing loans.
The recent announcement of a 25-basis point cut was met with jubilation – this finally means interest rates will drop… right?
Well, it’s not that simple. The relationship between Fed rate cuts and commercial lending is complicated. Reductions in the federal funds rate don’t always translate directly to lower long-term borrowing costs, as these are influenced by broader market dynamics. CRE investments often have long timelines, and the lag between a rate cut and tangible market benefits can span several months or even years. Investors should be prepared for a phased recovery, particularly in sectors with inherent challenges like office and retail.
If borrowing rates do begin to decrease, cap rates (the ratio of a property’s NOI to its market value) typically take six to nine months to reflect a correction. This could create the opportunity for attractive investments that offer lower borrowing costs coupled with higher cap rates. Savvy investors should stay alert because the window of opportunity for this imbalance is short-lived.
Although we can’t predict when and how much CRE interest rates will drop, something less tangible has increased because of the first rate cut: investor sentiment. Investors are increasingly optimistic that we have made it through the worst, and that lease and sale transaction volume will rise in 2025.
The anticipated reductions in interest rates are welcome news for the CRE market, but patience is essential. The timeline for CRE interest rate adjustment remains uncertain, but signs point to gradual improvement starting in the next 12-24 months. Understanding sector-specific factors and staying informed on economic developments will be crucial for navigating this evolving landscape.
Justin Langlois, CCIM is a Commercial Real Estate Advisor with Stirling Investment Properties servicing Baton Rouge, Louisiana and surrounding markets. Please reach out to Justin to discuss your real estate investment strategies.