Following the Federal Reserve’s December meeting in which the overnight rate was held flat, Chairman Powell made a couple statements that potentially altered the trajectory of capital markets and the commercial real estate investment outlook. In addition to signaling that the Federal Reserve is likely done raising rates this cycle, Chairman Powell opened the door to the possibility of reducing rates in 2024. A key point was that the Federal Reserve would likely need to begin reducing rates before inflation reached the Fed’s 2 percent target. The 10-year treasury immediately responded, dropping 15 basis points to 4 percent. Considering that the 10-year was on the doorstep of 5 percent in mid-October, this significant rate reduction offers investors a much more promising outlook for 2024.
While the Federal Reserve left the door open to additional monetary tightening if needed, the broad consensus is that interest rates will continue to migrate lower. These factors could structurally change investor underwriting and real estate investment strategies. Although cap rates have risen substantively over the course of the last two years, most institutional-grade properties continue to trade with yields below the cost of debt capital, and few institutions are willing to acquire new assets using negative leverage. As a result, the institutional investment market has been very slow over the last year. Looking forward, the declining 10-year treasury offers the prospect of closing the buyer-seller price expectation gap and reinvigorating institutional commercial real estate transaction activity.
