A rate cut by the Federal Reserve could help reverse the decline in commercial real estate. However, investors should exercise caution when venturing into the market. Wells Fargo said in a Sept. 25 report that central bank policymakers’ half-percentage rate cut last month “marked the beginning of the worst commercial real estate downturn since the global financial crisis.” “Lower interest rates are not a panacea, but less restrictive monetary policy sets the stage for a recovery in commercial real estate,” senior economist Charlie Dougherty wrote. “Falling long-term rates appear to be easing the pressure on cap rates Upward pressure has slowed the decline in real estate valuations. At the same time, increased expectations for a soft landing in the economy seem to be giving capital a green light to no longer wait and see,” he added. There are some bumps in the road. The 10-year Treasury yield rose above 4% on Monday for the first time since August, following Friday’s better-than-expected jobs report. Bond yields are inversely related to prices. 1 basis point equals 0.01%. Federal funds futures trading suggests there is about an 84% chance of a 25 basis point rate cut at the next Fed meeting in November, while no one expects another 0.5 basis point rate cut, according to data from CME’s FedWatch tool. Of course, there are hurdles ahead of the market, especially office space, Dougherty said. “That said, lower interest rates should prevent contagion and shorten future roadblocks,” he added. Lower refinance rates for borrowers Companies that have been stretching out mortgage deals in a high-rate environment will get some relief and eventually be able to refinance at lower rates, said Douglas Gimple, senior portfolio specialist at Diamond Hill. As of Sept. 30, about 25% of the portfolio of his firm’s Short-Term Securitized Bond Fund (DHEIX) was in nonagency commercial mortgage-backed securities. ‘s magic bullet,'” Gimple said. “It’s not going to happen overnight because we know that when the Fed takes action – whether it’s higher or lower – it takes a while for it to work its way through the system.” He thinks investors can now see through Discover value by focusing on bottom-up processes. “If you can find rough diamonds that are compromised from a pricing perspective because they’re tied to commercial real estate, then you can find some really good opportunities,” he said. “You just have to be careful.” Know What You’re Buying Investors should know what their managers are buying or, if they’re investing their own money, what they’re buying, he said. Gimple particularly likes single-asset, single-borrower CMBS and commercial real estate mortgage obligations. As the name implies, the former involves a single asset (such as a high-end hotel) or a single borrower (which could be a hotel chain with multiple locations). The latter are short-term, floating-rate deals typically done by companies to upgrade properties, such as installing swimming pools or energy-efficient air conditioning in apartment complexes, he said. Every investment is also always contingent on transactions, Gimple said. He wouldn’t buy office space in Los Angeles or New York, for example, but might consider suburban deals. He would consider Class A offices, which are typically the most modern, with occupancy rates as high as 95% and a diverse population of residents. In hotels or lodging, he looks at “trophy” properties in areas like Miami or Hawaii. “It’s not about the hotel, it’s about the location,” Gimple said. He also focuses on single-family rentals and industrial, and to some extent retail. Any CMBS holdings should be just one part of a diversified fixed-income portfolio that includes credit and Treasuries, he said. “It depends on risk appetite, which will determine what allocation they should consider,” Gimple said. “If you avoid the entire market just because you read the headlines, you’d be remiss as an investor. There are still opportunities out there.”
A rate cut by the Federal Reserve could turn the tide for commercial real estate. where to find opportunities | Real Time Headlines
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