Fed cuts could turn things around for commercial real estate. Where to find opportunities?
Federal Reserve interest rate cuts could help turn the tide for commercial real estate. However, investors should be cautious when entering the market. Wells Fargo said in a Sept. 25 note that the half-point cut by central bank policymakers last month “marks the beginning of the end of the worst of the CRE downturn.” since the global financial crisis”. “Lower interest rates are not a magic bullet, but less restrictive monetary policy will lay the foundation for a recovery in commercial real estate,” senior economist Charlie Dougherty wrote. “Falling long-term interest rates appear to be easing the pressure on rising cap rates and slowing the decline in asset values. Meanwhile, growing expectations of a soft landing in the economy will turn on the lights green for capital to escape from the margins,” he said. added. There are some bumps in the road. On Monday, the 10-year Treasury yield rose above 4% for the first time since August, following a better-than-expected jobs report on Friday. Bond yields move inversely to prices. One basis point equals 0.01%. According to CME FedWatch Tool, Fed funds futures trading shows the likelihood of a 0.4-point rate cut at the Fed’s next meeting in November is about 84%, while no one expects a cut. half a point less. Of course, Dougherty said, there is no shortage of headwinds ahead for the market, especially for office space. “That said, lower interest rates will prevent widespread hardship and shorten the impending hurdles,” he added. Douglas Gimple, senior portfolio specialist at Diamond Hill, said companies, who have extended mortgage deals through the higher interest rate environment, will see some relief and may eventually Refinance at lower interest rates. His firm’s short duration securities fund (DHEIX) had about 25% of its portfolio in non-agency commercial mortgage-backed securities, as of September 30. DHEIX YTD Mountain Short Duration Securitized Bond Fund so far,” Gimple said. “It won’t happen overnight, because we know that when the Fed takes action – whether higher or lower – it takes some time for it to work in system.” He thinks investors can now find value by focusing on the bottom-up process: “If you can find rough diamonds that are price-compromised by association,” he said to commercial real estate, then you can find some really good opportunities.” “You just have to be cautious.” Know what you’re buying. Investors should understand what their managers are are buying or if they’re investing on their own, understand what they’re buying, he said. Gimple especially likes single-asset, single-borrower CMBS and commercial real estate collateralized loan obligations. The former, as the name implies, involves a single property — like a high-end hotel — or a single borrower, which could be a hotel chain with multiple locations, he said, and the latter are allotments Short-term financing has a floating interest rate and is typically done by a company to upgrade a property, such as installing a swimming pool or energy-efficient air conditioning for an apartment complex, Gimple said Investment will also always depend on the agreement. For example, he wouldn’t buy office space in Los Angeles or New York but might consider a deal in the suburbs. He will look at Grade A offices, which are typically the most modern and have a 95% occupancy rate with a diversity of occupants. In hotels or motels, he looks at “trophy” properties in areas like Miami or Hawaii. “It’s not really about the hotel, it’s about the location,” Gimple said. He also looks at single-family rentals and the industrial and retail sectors to a certain extent. Any CMBS holdings are just part of a diversified fixed-income portfolio that includes credit and Treasuries, he said. “It depends on risk tolerance to determine what type of allocation they should consider,” Gimple notes. “As an investor, you would be remiss to avoid an entire section of the market just because of the headlines. There are still opportunities there.”
