The commercial real estate market stands to benefit greatly if the Federal Reserve follows through on its expected interest rate cuts this year. High interest rates have led to 60% fewer commercial real estate transactions in 2023 compared to 2021, Lawrence Yun, chief economist for the National Association of Realtors, said Thursday at the association's quarterly Real Estate Forecast Summit. Lower rates would mean a recovery for the industry and collateral values, as well as increased transaction and leasing activity.
The Fed decides when to cut interest rates based on certain data points. One of those data points is consumer price inflation, which is currently at 3.1%. The target is 2% or a little lower. “Some people might scratch their heads and say, '3% and 2% are pretty much the same,'” Yoon said. But economics dictates that 2% is better than 3%, he added.
Despite the need to reach the 2% target, Yoon said he expects to see the following indicators of progress:
The Fed is expected to cut interest rates four to six times over the next few years. “What doesn't happen this year will just be postponed to next year. Inflation will be fairly subdued from the second half of this year through 2025,” Yoon said. The 10-year Treasury yield is expected to settle at 3.5%. Commercial property prices are expected to stabilize and recover, although challenges remain for the office sector. Moderate GDP growth is expected to continue to benefit net rental and investment sales. Land and single-family home development is expected to perform well.
Yoon said economists and the Fed are analyzing rents as a key data point in their ongoing interest rate assessments. Much of the data suggests rents aren't rising as much as the Consumer Price Index indicates. Using a different data set could have implications for monetary policy, and commercial real estate is highly sensitive to the path of monetary policy. “Measuring rent growth is a key input into gauging inflation,” said Igor Popov, chief economist at Apartment List. “And of course, the way in which inflation is measured is important in determining what the Fed will do next.”
CPI data comes from the Bureau of Labor Statistics and measures how much Americans are paying for rent. But when rents spike and then settle, renters don't feel the impact until they renew their lease or move — and that takes time. Popov said his firm's research has found a lag between CPI rent estimates and actual market trends. “We know that market rent growth peaked almost six quarters ago. It takes time for most of the slowdown in rent growth to be reflected in the CPI. We currently estimate it will take about six quarters,” he said.
After analyzing rent growth in major metropolitan areas, Apartment List identified the Sunbelt as the region in the U.S. where rents are falling the fastest, with Austin, Texas, leading the way, followed by Atlanta, Jacksonville, Fla., and Raleigh, N.C. These cities are also seeing job growth, attracting renters to live there.
The big story here is supply, Popoff said. There are a lot of apartment complexes coming on the market in the Sunbelt, putting a lot of pressure on prices. Prices in these areas have been trending down from their peaks, and new rentals coming on the market are giving renters more options. So it's not that these metro areas are less popular with renters or that they're experiencing lower job growth than other areas; it's that they're giving renters more options, lowering rents.
Meanwhile, Midwestern markets topped the list of cities with the fastest rent increases, including Grand Rapids, Michigan; Milwaukee; St. Louis; and Louisville, Kentucky.
Popov noted that vacancy rates in the multifamily sector continue to rise. “The National Vacancy Index has shown that over the past 28 months, vacancy rates have risen and, conversely, occupancy rates have consistently fallen. At the end of the 2021 boom, there were very few chairs left in the multifamily game of musical chairs. However, the market continues to ease.”
Nearly 1 million apartment buildings are currently under construction, and Popov's firm expects more than half to hit the market in 2024. That will keep rents under pressure, he said.