How will the Fed’s pivot to cut rates impact development, M&A?

He suggested, interest rate cuts, when they come, will help reduce the difference between the bid and ask in today’s market. “However, investors may wait and see how much the Fed cuts rates,” he said. “A small initial rate cut may leave investors holding out for deeper cuts to follow.”

Significant rate cuts should be very good for the CRE market and a significant step in the right direction, according to Brian Waldman, chief investment officer at Peachtree Group, Atlanta. “The Fed’s actions over the past few years have created real pressures across the commercial real estate industry and resulted in a high degree of uncertainty,” he said. “This has led to transactional and capital markets gridlock. There is still a tremendous amount of dry powder on the sidelines and those investors have been waiting for the right time to jump back in. When the Fed initiates rate cuts, it should lead to greater confidence for investors to re-enter the market and start to transact again.”

In conjunctions with rate cuts, Waldman said he expects to see a surge in demand for both acquisition and lending opportunities. “The anticipated uptick in activity will likely be a major boon for Peachtree Group, presenting opportunities to assist groups in recapitalizing their assets as well as growing our owned hotel portfolio,” he said.

A little less enthused about the pending cuts is Ferit Ferhangil, partner, principal and newly named CEO of Miami-based hotel investment and ownership firm Waramaug Hospitality, who said he is expecting three 25bps cuts.

“Short term, there will be little impact, since most of the rate cuts are expected to occur in the latter part of 2024,” Ferhangil said. “There is some reduction in pressure on financing tied to 5- and 10-year treasuries early in the year, but most floating rates will not see a benefit from these rate cuts for much of the year.”

Turn around assets and value-add assets will remain challenging, as we do not expect floating rates to lower impactfully in 2024.

Ferit Ferhangil

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As a result, he said Waramaug expects to look at acquisitions with a reliance on longer term debt, which requires focus on assets with strong cash flows. “Turn around assets and value-add assets will remain challenging, as we do not expect floating rates to lower impactfully in 2024,” Ferhangil said.

He added that the Fed’s announced pivot is not going to be enough of a rate drop to impact dealmaking appetite in development, conversion, or value-add assets. “The impact of the expectation of further drops in subsequent years will have a positive effect on CMBS and other long-term loans, therefore making dealmaking possible in a subset of the market with strong and steady cash flows,” Ferhangil added.

Ferhangil is also not betting on any noticeable impact on development and conversions since they rely on loans tied to short-term rates, which are expected to remain high through much of 2024.

A meaningful reduction in rates will, in fact, benefit new construction, acquisitions and conversions, Waldman argues. “However, keep in mind that construction and renovation costs have increased significantly over the past several years and even with rate cuts, certain projects will likely still not make economic sense,” he said. “I would argue that many of those projects should not have moved forward in the first place, but that should continue to be a governor on new construction. Limiting new supply in the near term will also benefit existing supply.”

Pillsbury called the availability of debt the second issue impacting the market, adding that The Fed has been shrinking its balance sheet, reducing the amount of capital banks have available for lending. “Also influencing that are bank underwriting standards and reserve requirements,” he said. “Today, there simply is not a lot of debt capacity in the banking system.”

Even though we may be operating in the ‘new normal’ of higher rates compared to where we were pre-pandemic, the anticipated cuts will likely provide fuel to the market for investors to re-engage and the market can then determine the appropriate pricing.

Brian Waldman

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Next, Pillsbury cited leverage as an influential factor on what happens next, suggesting real estate values are depressed from recent historic highs. As a result, even at the same leverage levels, loan proceeds are lower and he said many lenders have reacted by reducing the amount of leverage, requiring buyers to put up higher amounts of equity.

The fourth factor, according to Pillsbury, is investors’ appetite for existing versus new assets. “If the ‘credit cliff’ that threatens the refinancing of huge chunks of commercial real estate materializes, investors are likely to be bargain hunting among existing assets rather than taking the higher risk of new development,” he said.

The unknown in the rate equation is the upcoming presidential election. “Historically, the Fed does not want to influence election outcomes with its policies,” Pillsbury added. “Stimulating the economy and reigniting the economy could be very beneficial to the incumbent, and less beneficial to his challenger.”

Bottom line for Pillsbury: “We should see a healthier real estate investment market next year, although new development likely will continue to struggle to get financing early in the recovery.”

Bottom line for Ferhangil: the projected rate cuts will lead to some impact on the higher quality assets which would qualify for CMBS loans, but generally he does not see any meaningful impact on the rest of the broad market.

Waldman concluded that he believes psychology is a large part of what drives the market. “Even though we may be operating in the ‘new normal’ of higher rates compared to where we were pre-pandemic, the anticipated cuts will likely provide fuel to the market for investors to re-engage and the market can then determine the appropriate pricing.”