How the Fed's Rate Hike Impacts CRE

Good morning,

The Fed’s projected 25 bps rate increase impacts commercial real estate, bank regulators issue new policy to help lenders restructure loans, and the hottest office market in the country. Let's delve into today’s topics.

📈 Market Update

🫰 How the Fed’s 25 bps Rate Hike Impacts CRE

The market is largely predicting another 25 bps rate hike on Wednesday, July 26th, bringing the funds rate up to 5.25% - 5.50%. The Fed has also raised projections to peak at 5.50% - 5.75% in 2023, implying another rate increase beyond July’s anticipated hike. This has obviously led to a sharp decrease in property values and transaction volume. $130.5B of CRE traded in the first 5 months of 2023, a 61% drop from the same period in 2022.

Debt financing: Transaction volume is down not due to availability of debt, but the high cost of debt according to a Green Street analyst. Loans are often pegged to the 10 year treasury, and you can expect transactions to remain muted until the Fed / 10YR UST stabilize. Loan closings are down 33% since Q4 2022. Any property below an 8% debt yield is subject to higher credit risk.

Big picture: Office has a relatively dim outlook due to high vacancy rates and WFH trends. However, multifamily and industrial are expected to revert to high growth as capital markets stabilize and uncertainty is reduced.

🏦 Bank Regulators Urge Flexibility in Loan Workouts as Defaults Mount

Bank regulators have issued a new statement for lenders on how to restructure and / or extend loans without necessarily having to take losses. Based on policies set during the 2008 crisis, the updated policy urges flexibility and demonstrates how to modify loans to not take a loss even if the property value is less than the debt. This is contingent upon borrowers willingness and ability to repay the debt. Over $1T of loans backed by CRE will come due this year and next.

Mixed verdict: Some feel that this will help ease strain on the banking system and bridge the gap for CRE until capital markets stabilize. Others think this is an “extend and pretend” policy, delaying billions of dollars of doomed loans rather than dealing with the problem now. Only time will tell!

🏢 Midtown Manhattan - The Hottest Office Market in the Country

The office sector has certainly dealt with its share of pain due to high interest rates and lack of demand. To no one’s surprise, net absorption of office space has been negative nationwide. However, Midtown Manhattan has seen positive net absorption of 3.3M SF over the past year despite the mass NYC exodus narrative. Nashville, Brooklyn, Memphis, & Miami round of the top net absorption markets by SF.

Despite Midtown showing positive signs of life, office vacancy remains high. Midtown’s vacancy rate is 22.4%, above the national average of 19.2% and twice what is was before the pandemic. It’s also the highest its been since Cushman & Wakefield started tracking it in 1984. San Francisco, Philadelphia, Chicago, Boston, and Phoenix underperform.

📊 Chart of The Day

📑 Further Reading

• Multifamily Cap Rates Stabilize After Three Quarters of Increases (GlobeSt)

• How Financial Crises Shaped the Federal Reserve (WSJ)

• 2023 REIT Trading Trends (CPE)

• NYC Investment Sales Plummet 36% in 2023 (RealDeal)